Intermediate macro

Pre-tutorial #10

Tutorial 10: week starting October 19th

Pre-tutorial work

Reading guide

Review chapter 17, chapter 18, and sections 19.1-19.2 of chapter 19 of the textbook as preparation
for this tutorial. You should also look over your lecture notes.

Key concepts

Openness in goods and financial markets. Goods markets in an open economy. Uncovered interest
rate parity.

Problems
1. You should be able to tell whether the following statements are true, false or uncertain and also
be able to justify your answer.

(i) Uncovered interest rate parity implies that interest rates must be the same across countries.
(ii) The nominal exchange rate and the real exchange rate usually move in the same direction.
(iii) A real appreciation means that domestic goods become more expensive relative to foreign
goods.

2. Suppose the one-year nominal interest rate is 2.0% in the United States and 4.0% in Australia.
Should you hold Australian bonds or U.S. bonds? Explain.

3. You should be able to tell whether the following statements are true, false or uncertain and also
be able to justify your answer.

(i) Trade deficits usually reflect high investment.

(ii) Budget deficits cause trade deficits.
(iii) The only way a country can eliminate a trade surplus is via a real appreciation.
(iv) If the trade deficit is zero, the domestic demand for goods and the demand for domestic
goods are equal.
Intermediate macro: Pre-tutorial #10 2

4. The potential effects of a recession in Japan on Australian GDP.

(i) The share of Japanese spending on Australian goods is 20% of Australian exports, which
equals about 23% of Australian GDP. What is the share of Japanese spending on Australian
goods relative to Australian GDP?
(ii) Assume the Australian multiplier is 2, and that a recession in Japan has reduced output
by 5% relative to its natural level. What is the impact on Australian GDP of the Japanese
slowdown?
(iii) If the Japanese recession also leads to a slowdown of the other economies that import
Australian goods, the effect could be larger. Assume that Australian exports fall by 5%
in total. What is the impact on Australian GDP?
(iv) Comment on the following statement: “Unless Japan recovers from recession quickly,
growth will grind to a halt in the rest of the world”.

5. Net exports and foreign demand.

(i) Suppose that there is an increase in foreign output. Show the effect on the domestic
economy (that is, replicate Figure 19.4 in the textbook). What is the effect on domestic
output? On domestic net exports?
(ii) If the interest rate remains constant, what will happen to domestic investment? If taxes
are fixed, what will happen to the domestic budget deficit?
(iii) Using N X = S − I + T − G, what must happen to private saving? Explain.
(iv) Foreign output does not appear in the equation in part (iii), yet it evidently affects net
exports. Explain how this is possible.