Past paper questions Flashcards
Widespread capital flight led to a collapse in the value of the peso, so that Argentina was forced to seek a bail-out package from the IMF. However, the IMF made the bail-out loans contingent on the Central Bank of Argentina’s non-intervention in the foreign exchange markets.
What was the unintended consequence of this policy?
[7m, 2020]
- Consequence: a SPECULATIVE ATTACK on the currency.
- Market speculators expected the exchange rate to DEPRECIATE given that the central bank was no longer permitted to defend the currency.
- They therefore SHORT-SOLD the peso whilst its value was high, in anticipation of buying back once the price had fallen and thereby banking huge PROFITS.
- Through their actions, they caused the value of the peso to collapse further.
In recent years, many advanced economies have experienced declining unemployment but without rising
inflation.
How might the rise of automation in the workplace explain this puzzle?
(Phillips curve diagram).
[10m, 2020 paper]
[similar Q with exact same answers in 2021 paper]
- focus on the effects of automation in decreasing workers’ wage bargaining power.
- The government boosts aggregate demand and moves up the SRPC, unemployment falls but workers are reluctant to bargain for higher wages due to the threat of being replaced by a cheaper robot.
- So firms don’t increase prices
much and inflation does not increase much, i.e. the slope of Phillips curve flattens. - Although inflation expectations
have increased, workers do not negotiate for higher wages for similar reasons. - So the SRPC does not shift up,
- and because the EROSION in real wages is NOT REVERSED, unemployment falls permanently and so the economy converges to a new long run equilibrium in which the natural rate of unemployment has decreased but without inflation picking
up.
If markets are expecting the central bank to cut rates in the coming years, what does this indicate about future economic conditions?
Indicates an oncoming RECESSION
During the Greek sovereign debt crisis, in negotiations with Greece on the terms of the third bail-out package, the German Chancellor Angela Merkel pushed for swingeing austerity cuts as a condition for approving the bail-out deal.
Why did she believe this would be (i) good for Greece, and (ii) good for the Eurozone as a whole?
[2021 paper]
- Merkel believed austerity cuts were good for Greece as the benefits of improving debt sustainability
(in terms of a lower country risk premium) outweighed the cost in terms of sapping aggregate demand. - This stems from the view that the fiscal multiplier is small due to Ricardian equivalence, hence austerity measures would decrease significantly the debt to GDP ratio without harming aggregate demand too much.
- Benefits to the Eurozone came from preventing contagion. If Greece were to default, this would raise concerns about other countries’ excessive debt burdens setting of a cascade of further defaults through a SELF-FULFILLING EQUILIBRIUM and risking collapse of the euro.
Context: Currency risk premium increases.
Could MONETARY POLICY have stabilised the economy? Assume that Argentina is a small, open economy with a FIXED exchange rate.
Write the concluding statements.
[2020 paper]
- Monetary policy is ineffective in stabilizing output under fixed exchange rates.
- A monetary expansion temporarily increases income, but this causes an exchange rate depreciation.
- Central bank intervenes by buying pesos, which contracts the money supply and hence exchange rate reverts to target but income reverts back.
What moral hazard problem does a “too big to fail” bank create?
[2019 paper]
- None of the banks creditors have much incentive to monitor the bank by examining its activities closely and pulling their money out if the bank was taking excessive risks.
- Consequently, “too big to fail banks” are likely to take on even greater risks, hence making bank failure even more likely.
