MIBIS/ECONOISP2/ENGITZOXX ‘Answer one question from this section. 1 {sources adapted rom wi. sco0p.c0 ne, aeeasad 1 Saplembit 2018 new boomberg com, acpessed 1 Septomber 2018 (This question continues on the following page) ‘Study the extract below and answer the questions that follow. Now Zealand's overvalued exchange rate ‘The New Zealand dollar (NZS) remains overvalued and within three months has risen more: than 6% against the US dollar. The New Zealand central tank recently cut inerest rates to ‘a record low of 236. Rather than causing a depreciation ofthe NZS as expected, increased ‘Speculation resuited in a further 1% appreciation ofthe curtency. The latest interest rato cut ‘was the sith in fourteen months, However, monetary stimulus in many countries and the US Central Bank's fallure to increase interest rates have kept New Zealand's exchange rate overvalued. The strengthening of the currency has delayed an expected increase in infation, In global environment of disinflation end widespread central bank stimulus, the [New Zealand central bank has the responsibilty for raising inflation from 0.4% toits 1% to 3% target band. To achieve this, the price of mports needs to rise. Under normal circumstances the central bank would further lower interest rates to raise inflation, However, the New Zealand property market is overneating and any further cuts ‘would worsen tis ‘Afurther issue forthe central bank is that economic growth is forecast to accelerate to 13.5% next year. According to the gavernar ofthe central bank, reducing interest rates. “rapidly to around 0% lke other developed countries, will cause the economy to overheat. ‘The governor must balance the need to raise inflation to within the target band, but without exceeding it. “The New Zealend Manufacturers and Exporters Association (NZMIEA) are also calling for ‘action to weaken the NZ$ because they ciaim that the current exchange rate is too tigh. In adtion, the overvalued exchange rate makes it more challenging to raise infiaton. ‘A spokesperson for NZMEA claimed that “the exchange rate has been persistently high over the ast decade. If we are to meet our goals of increasing exports as a percentage of GDP ‘and encouraging futher investment in ski, technology, and research and development, the exchange rate must fall. “The strong NZS is of such a concem that multinational corporations, specializing in high-value manufacturing, are starting o relocate some operations off shore. Local manufacturers, who supply many of the inputs used by the multinational corporations are being harmed, ‘and Mp investing com, accessed 1 September 2016]MIB/VECONOISP2IENGITZONX (Question 1 continued) (@) (Define the term disinfatin inated in bon he txt (paragraph ©), a {Define the erm mutational eoppratons indicated in olin he text (paragraph 0) a {b)Usng an exchange rate cagran, explain how te “increased speculaon suited in a further 1% appreciation ofthe curency’ (paragraph 41 (©) Using an ADIAS diagram exlin why “he price fpr needs to ie to rage ination (paragraph @), @ (@) Discus the impacts ofthe overvalued cureney on New Zesland’s econo. 8 Tum overait; M18/3/ECONO/MPZIENGITZOIKX 2. Study the extract and data below and answer the questions tht follow. Britain's current account d © 10.206 a public vote resulted in the decision that Btain would leave the European Union ‘This became known as “Brexi”. Since the Brenit vote, the pound (Britains currency) has. {allen from almost USS1.50 to around USS1.30 against the pound as a result of investor uncertainty © Currency depreciation can be a very useful too! for countries when they have become locked in o an overvalued exchange rate. For example, in 1992 Britain abandoned its ‘managed exchange rate system and the pound fel rapidly. Folowing ths, the economy picked up quickiy and the inflationary impact was limited. However, the circumstances at thal time were very cifferent; interest rates were 12%, there was a lot of spare capacity in the economy and unemployment was 10%. Now interest rates are just 0.5% and ‘unemployment is 5%. © Bftain's current account defect is at around 7% ofits gross domestic product (GDP), which is said to be ‘highly uncomfortable" (see Figure 1). Prior tothe Brexit vote, the deficit ‘was not seen as 2 concern due to the fact that Britsin was very successful in attracting foreign direct investment. Now, foreign investors are uncertain about economic prospects ‘and seem to be holding back on investments in Britain. The property market is also seeing signs of reduced demand, © One economist said that “there is a substantial danger thal the United Kingdom (UK) will find it increasingly hard to attract the inward flows of capital needed to finance the current ‘account deficit, particularly given its recent crecit rating downgrades and the very res! possibiity of more uncertainty’. A ratings agency predicted that investment wil fll by 6% in 2017 because of the uncertain climate created by the Brexit vote, In addition, the country vill struggle to attract foreign savers because intrest rales are near 2er0, © Theoretically, the fall of the pound will make Briish assets attractive to foreign investors. However, one research agency argues this may require a very steep depreciation of the ‘exchange rate. It estimates thatthe pound/dollar exchange rate wil settle at around USS!.42 tothe pound. In order to eliminate the curent account deficit the exchange rate ‘would have to fall to a value of US$1.00 tothe pound. This is unlikely tohhappen. © _Intheory, depreciation could be good for exports. Britain experienced one big depreciation inthe pound in 2009, which reduced the current account deficit for a while, but the elect was ‘only temporary, © Another economist indicated that Britain's current account deficit wil mit the government's fiexibilty in the use of demand-management policies. {Souwces: adapted rom wa economist com, 7 iy 2016; want econois com, 9. dy 2016 ‘nd wav tbe com, 30 une 2076) (This question continues on the following page) a(Question 2 continued) M18/3/ECONOMHP2/ENG/TZOXX, Figure 1 — Data for the British current account (2000-2016) Britain's current account deficit as % of GDP % of GDP (Source; Bank of England, Haver Anais] (@) (i)__Define the term depreciation indicated in bold in the text (paragraph (i) Define the term foreign direct investment indicated in bold in the text (paragraph ©). (©) Using an exchange rate diagram, explain why “investor uncertainty" resulted in a fallin the value of the pound (paragraph 0). (©) Using a Keynesian AD/AS diagram, explain the meaning of the phrase “alot of spare capacity in the economy" (paragraph @). (@) Using information from the text/data and your knowledge of economics, discuss the consequences of a persistent current account deficit for the British economy. 2 2 4) 4) (8) tf Tum over