1. If a country’s consumption is based on the permanent income theory, suppose that today’s income (period 1) is $100 and is expected to rise to $200 and $300 in period 2 and 3, respectively. Assume that the planning horizon is of course three periods, and that the interest rate and the rate of time preference are both zero. Also assume that investment and government expenditure are nil. (a) What would be the optimal consumption?(b) Now suppose that the expected income for period 3 goes up to $600. What would happen with optimal consumption? (c) What is the current account balance in period 1 under both scenarios? What equation seen in class would explain this current account behavior? (d) Imagine now a closed economy. Given this income profile over time, what would be the consumption in each period under the initial scenario? 2. Consider a large economy, say the United States, that has influence on the determination of the international interest rate. Explain what should happen to this international interest rate if the following changes take place in the U.S.: (a) the old age dependency ratio increases; (b) The GDP growth rate becomes much more volatile; (c) The federal deficit increases; (d) A massive credit promotion policy is implemented allowing a large number of households and firms to obtain loans.3. In the cases presented in question (2), if the U.S. current account was initially balanced, how would this current account balance be affected by each of the above changes?4. Based on actual data, is it true that households save but do not invest and businesses invest but do not save?5. What is the difference between (i) quantity- vs. price-based, (ii) flow- vs. stock-based; and (iii) financial- vs. real asset-based capital mobility tests.6. What is the typical stock and flow measures of capital mobility and why do they tell quite a different story about the degree of capital mobility around the world? And what difference makes, in terms of perception, referring to dollar volumes or GDP-scaled values?7. Why do financially open countries that have adopted the dollar or the euro as legal tender still display interest rates that are above those in the U.S. or Germany?8. If a country running current account deficits and diminishing reserves introduces a fixed exchange rate, should we say that this policy move will reduce the interest rate by eliminating the expected devaluation component of the interest rate?9. What is the difference between the covered and the uncovered interest rate parity?10. What is the main different between the interest rate parity and the law of one price for tradable goods?11. Explain the meaning of the equity home bias (EHB) coefficient and summarize the available evidence.12. Is it true that the higher the risk aversion the less sensitive is the share of home assets to the differential return between home and foreign assets? 13. Is it true that the higher the correlation between home and foreign returns the lower the benefits of international diversification? What has happened with these correlations in recent years and during crises?14. Is it true that if investors have 99% of their portfolios in home assets, then those investors exhibit home bias?15. Why do we say that, based on a risk/return analysis, U.S. investors show home bias?16. Why do we say that exchange rate risk has not been a major cause of home bias in Europe? 17. What are the asymmetric information and behavioral explanations to the home bias? How reasonable do they sound? Should they be equally applicable to small and big, professional investors?18. Explain the risk sharing test of capital mobility and comment on the corresponding evidence. 19. Explain the marginal productivity equalization test and discuss the role of the total factor productivity (the parameter A in the production function) to solve the seeming puzzle presented in the data. How big are these productivity cross-country differences and what explains them?20. Why do some analysts argue that emerging countries may be investing heavily in physical capital but still run current account?21. What do we mean by convergence and what does the data say about it?22. What is the Feldstein-Horioka test? Are the empirical estimates consistent with the conclusions from the home bias and the risk sharing tests?23. Is it true that “FDI reaps huge returns in host countries and profits are fully repatriated to headquarters”?24. Is is true that “Emerging countries mostly receive short-term, volatile capital flows, not much FDI”?25. Why is intertemporal solvency a concept difficult to operationalize and what is the advantage and the limitation of the standard external debt sustainability analysis?26. What effects do negative current accounts and NIIPs have on the probability of external crises?27. What are the foundations and the use of the studies on country risk premium and how good are the empirical models in explaining this variable?28. Why do we say that credit ratings are good predictors of interest rate spreads (risk premium) but they do not seem to internalize all the relevant information for investors?
This question was answered on: Sep 21, 2023
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