Initials: _______

Name (first & last): _____________________________________________ Exam version: 1

Student number (not UvAnetID): __________________________________

Course: IMB / IM (encircle your course)

EXAM

INTERNATIONALE MONETAIRE BETREKKINGEN (IMB, 6012B0231)

/
INTERNATIONAL MONEY (IM, 6012B0320)
<time> (2.5 hours)

If instructions below differ from the ones of the trial exam on Blackboard, they are in grey.
Instructions regarding the organisation of the exam
 Please write down (right now):
o At top of this page: your name, student number, and the course you take.
o At top of EVERY odd page of this exam: initials of your first and last names.
o On separate multiple-choice answering card: your name, student number, course (IMB or IM),
and exam version (see top right of this page, to be filled in on the card at “versie code”).
 Only the following items are allowed on your table: the exam and other materials provided by the
invigilators, your student card with photo (in corner of table), a pen, pencil and eraser.
 A dictionary is not allowed.
 If you have a question, please raise your hand and remain seated.
 Electronics (e.g., phones, smartwatches, and calculators) are not allowed in the exam room.
 If instructions are not observed, you can be excluded from the exam.
 Before the exam you must bring your coat and bag to an indicated central place, where you will
also get it back after the exam; the invigilators are not responsible for your belongings.
 It is not allowed to go to the toilet. It is thus advised not to take (too much) water to the exam.
 It is not allowed to leave the exam room within half an hour after the start of the exam. After that
first half hour students can no longer enter the exam room and one can only leave the room after
approval by the main invigilator and after handing in all materials mentioned below.
 You have to hand in all sheets of this exam (DO NOT DETACH THEM), the multiple-choice
answering card, and any additional paper. You may tear off the small bottom part of the last page.
 [This info is also available on Blackboard:] The exam grades will be posted on Blackboard on
<date> at 16:00 at the latest. The exam review date is <date>. If you want to look into your graded
exam, you should write an email to f.klaassen@uva.nl before <date>, 16:00, with subject
“Tentameninzage IMB” or “Exam review IM” and possibly containing class times on the review
day. The review time schedule will be emailed to you before the end of that day.
 As usual, the Teaching and Examination Regulations apply.

Instructions for answering the exam questions

 Answering open questions:
o Please write your answer in the (more than enough) space below each question.
o IMB-students may answer in Dutch, of course.
o Answer briefly, but ALWAYS CLARIFY YOUR ANSWER, unless explicitly stated
otherwise. Do not digress too much: incorrect or irrelevant remarks could cost you points.
o Text that is difficult to read will not yield points. You may use symbols and arrows.
 Answering multiple-choice questions: use the separate card and a pencil (Dutch: potlood) as usual.
 For all exam questions, the usual exchange rate definition is used, that is, the number of domestic
currency units per unit of foreign currency. Undefined symbols are interpreted as in class.

GOOD LUCK!
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Multiple choice questions (maximum total number of points: 46)

Question 1 (3 points)
Which of the following is equal to the real exchange rate?
1. P / (P* S)
2. P* / (P S)
3. S P / P*
4. S P* / P

Question 2 (4 points)
Consider the foreign exchange market between the euro zone and the United States. Supply and
demand are solely determined by the goods account of the balance of payments, and goods demand
depends negatively on the consumer price. In the graphical analysis of this model we put the exchange
rate (euros per dollar) on the vertical axis and the quantity of dollars on the horizontal one. Assume
that the prices of exports in the exporting country’s currency are constant. Also assume that the
demand elasticities x and m of the euro zone are both above unity.
Which of the following statements about the slopes of the demand (D) and supply (S) curves in the
graph is correct?
1. D is downward sloping and S is upward sloping.
2. D is downward sloping and S can be downward sloping.
3. D can be upward sloping and S is upward sloping.
4. D can be upward sloping and S can be downward sloping.

Question 3 (3 points)
Which parts sum up to make the total balance of payments (obviously defining the capital account as
in the course)?
1. Current account, capital account and official reserves account.
2. Current account, capital account, and financial account.
3. Trade account, current account, and capital account.
4. Trade account, capital account and official reserves account.

Question 4 (3 points)
Bulgaria follows a fixed exchange rate regime. Assume that it does not intend to change this and that
Bulgaria has a balance of payments deficit of 1000 levs (lev is the Bulgarian currency). Consider the
following statements:
I The Bulgarian central bank buys 1000 levs with its reserves.
II Bulgaria must have exported fewer goods than it has imported.
Which of the following is true?
1. Both statements are correct.
2. Statement I is correct, II is wrong.
3. Statement I is wrong, II is correct.
4. Both statements are wrong.

Question 5 (3 points)
Consider the following statements about the elasticity approach to the balance of payments.
I In the short run the Marshall-Lerner condition is usually not fulfilled, in the long run it is
usually fulfilled.
II If one does not assume infinite supply elasticities, a depreciation may improve the current
account even if the sum of the demand elasticities is less than one.
Which of the following is true?
1. Both statements are correct.
2. Statement I is correct, II is wrong.
3. Statement I is wrong, II is correct.
4. Both statements are wrong.
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Question 6 (4 points)
Consider the following statements within the framework of the Swan diagram.
I Under fixed prices, a fixed exchange rate makes it impossible to achieve full equilibrium
starting from a situation of unemployment and a deficit on the current account.
II Joining the euro zone facilitates the joint achievement of internal and external balance.
Which of the following is true?
1. Both statements are correct.
2. Statement I is correct, II is wrong.
3. Statement I is wrong, II is correct.
4. Both statements are wrong.

Question 7 (3 points)
Consider the BP curve in the Mundell-Fleming graph, where the interest rate and output are on the
vertical and horizontal axes, respectively. We have the following statements:
I The higher international capital mobility is, the steeper is the BP schedule.
II The BP schedule is upward sloping (ignoring limiting cases).
Which of the following is true?
1. Both statements are correct.
2. Statement I is correct, II is wrong.
3. Statement I is wrong, II is correct.
4. Both statements are wrong.

Question 8 (3 points)
Consider the concepts of absolute and relative purchasing power parity (PPP). Which of the following
statements is false?
1. Relative PPP is more likely to hold than absolute PPP.
2. If relative PPP holds, the depreciation of the home currency equals excess inflation in the home
country over the foreign country.
3. Both absolute and relative PPP can be represented in encompassing form as p = s + p* + c, with
a difference only in the restrictions on the constant c.
4. When expressing the log real exchange rate as q = s + p* - p, q must be equal to zero if relative
PPP holds.

Question 9 (4 points)
Consider the following statements on the risk premium:
I If there is no exchange risk, then the real exchange rate is perfectly predictable.
II If there is inflation risk, there is no exchange risk.
Which of the following is true?
1. Both statements are correct.
2. Statement I is correct, II is wrong.
3. Statement I is wrong, II is correct.
4. Both statements are wrong.

Question 10 (3 points)
Assume that there is no risk premium. Which of the following statements is correct?
1. Forex market efficiency means that st+1 is on average larger than ft.
2. Forex market efficiency means that st+1 is on average less than ft.
3. Forex market efficiency means that st+1 is on average equal to ft.
4. None of the above statements is correct.

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Question 11 (2 points)
Which of the following arguments cannot be considered a valid argument in favor of a fixed exchange
rate regime?
1. It promotes international trade and investment.
2. It avoids destabilizing speculation.
3. It insulates the economy from foreign price shocks.
4. It promotes discipline for macroeconomic policy.

Question 12 (2 points)
Which of the following claims concerning the initial setup of the Bretton Woods exchange rate system
is false?
1. In this system the US dollar was fixed to gold at 35$ per ounce.
2. Devaluations and revaluations against the dollar were possible.
3. Currencies were convertible for current account transactions.
4. Currencies were convertible for capital account transactions.

Question 13 (3 points)
If the assumption that we are moving to a bipolar world concerning exchange rate regimes is true,
which of the following regimes will not disappear?
1. Exchange rates within crawling bands.
2. Currency board.
3. Managed floating.
4. Pegged exchange rates within horizontal bands.

Question 14 (3 points)
Consider the following statements on the Hamada diagram.
I The policy configurations of the two countries are shown on the horizontal and vertical axes of
the diagram.
II There exist indifference curves of the two countries that are tangential on the Pareto contract
curve.
Which of the following is true?
1. Both statements are correct.
2. Statement I is correct, II is wrong.
3. Statement I is wrong, II is correct.
4. Both statements are wrong.

Question 15 (3 points)
Consider the following statements:
I The Treaty of Paris instructed Delors to develop a proposal for monetary integration of the EU.
II One of the elements of the Bretton Woods Treaty was the creation of the IBRD.
Which of the following is true?
1. Both statements are correct.
2. Statement I is correct, II is wrong.
3. Statement I is wrong, II is correct.
4. Both statements are wrong.

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Initials: _______

Question A (maximum number of points: 17)

The uncovered interest parity (UIP) is an essential concept in international monetary economics. In
this exercise you can apply it to your home country situation.
a) Write down the mathematical formula of the exact version of UIP; define the symbols you use.

b) Provide an economic argument that explains why uncovered interest parity holds. Also, make
clear what the meaning is of the terms “uncovered” and “interest parity”.

c) What is your home country and which country is the most natural reference for your home
country regarding financial issues (e.g., for home country Canada the reference country would
be the U.S.; if relevant in your case: treat the euro countries as a single country)?

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d) How large are the annual interest rates in your home and reference countries nowadays? The
answers need not be very precise, but should be representative numbers (e.g., 4% for Canada
and 4% for the U.S.).

e) Explain the interest differential.

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Initials: _______

Question B (maximum number of points: 23)

This exercise analyzes the effect of an unexpected but permanent productivity shock in the Dornbusch
model of exchange rate determination.
In the Dornbusch model, three markets play a central role, namely the money market, international
bond market and the goods market.
a) For each market, give the equilibrium condition and the equilibrating (market clearing) variable.
The equilibrium condition should show what variables affect the equilibrium; for example, y
and r affect money demand. You may use full formulas and symbols (probably the easiest thing
to do), but that is not necessary.

The Dornbusch model can be analyzed in a graph with the exchange rate (s) on the horizontal axis, the
price level (p) on the vertical axis, the MB curve reflecting equilibrium on the money and international
bond markets, and the GG curve that represents equilibrium on the goods market:
p
GG

MB

s
b) Explain precisely and in a structured way why the MB curve is downward sloping.

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In the initial situation, all three markets are in equilibrium. Suddenly, productivity increases, so that
goods supply (income, y) goes up. Assume that the parameters of the model are such that for the
productivity increase the nominal exchange rate does not change in the long run compared to the
initial situation.
c) Explain precisely whether and, if yes, how the MB curve shifts due to the productivity shock.

d) Explain precisely whether and, if yes, how the GG curve shifts due to the productivity shock.

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e) Use the graph to explain what the effect of the productivity shock is on the exchange rate and on
the price level, in the short, medium, and long run, subsequently.

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Question C (maximum number of points: 14)
This exercise is about the debt crisis of the early eighties.
a) Why did the developing countries need so much capital from abroad in the seventies?

b) How were the eurobanks involved in the emergence of the debt crisis?

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Initials: _______

c) Explain why the debt/exports ratio of the developing countries worsened substantially in the
beginning of the eighties, both through the numerator and the denominator.

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The next (empty) pages may be used as you like, for instance, if you need more space for
answering some questions. All pages have to be handed in together with the other pages
of this exam.

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 Initials: _______

To take away your own multiple-choice answers to compare to fellow students, END
1) ____ 4) ____ 7) ____ 10) ____ 13) ____ you may tear off this small part.
2) ____ 5) ____ 8) ____ 11) ____ 14) ____
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3) ____ 6) ____ 9) ____ 12) ____ 15) ____
Answers
Answer to question 1
Answer: 4.
Explanation: That is just the definition, see the slides on chapter 1. Note that answer 3 uses the English
exchange rate definition, which the course does not use, implying that answer 3 is incorrect.

Answer to question 2
Answer: 1.
Explanation:
Note that quantities of dollars are on the horizontal axis and the price of one dollar is on the vertical
axis. We first consider the demand for dollars and then supply.
Demand:
A lower exchange rate (cheaper dollar) will lead the euro zone to import more from the US, leading to
a higher demand for dollars (volume effect) while the goods cost the same amount of dollars as before
(the price effect is zero). Thus, the demand curve is downward sloping.
Supply:
A lower exchange rate (cheaper dollar) has two effects on the supply of dollars, and the slope of the
supply curve depends on which effect is stronger. Because of the appreciation of the euro, the US will
import less from the euro zone, leading to a lower supply of dollars (volume effect), but it will have to
pay more dollars for each unit of import because of the more expensive euro (price effect). Given that
the export demand elasticity of the euro zone exceeds unity, the volume of US imports from the euro
zone responds a lot, so it dominates the price effect. So the supply of dollars drops. Thus, the supply
curve is upward sloping.

Answer to question 3
Answer: 1.
Explanation: That is just the definition; see the slides on chapter 2. All other answers have something
that makes them wrong. For instance, 2 is incorrect in the book’s terminology, because the book
defines the capital (and financial) account as one account without the official reserves part.

Answer to question 4
Answer: 2.
Explanation:
 Statement I is correct: A BoP deficit means an excess supply of lev at the forex market. Because
Bulgaria wants to avoid a depreciation of the lev, it has to buy this excess supply with its reserves.
 Statement II is not correct: there can also be a BoP deficit for other reasons (statement II is more
similar to a trade balance deficit).

Answer to question 5
Answer: 1.
Explanation:
 Statement I is correct, see e.g. Pilbeam, Section 3.3.
 Statement II is also correct: with less than infinite supply elasticities, the conditions on the demand
elasticities under which a depreciation leads to an improvement of the CA change, allowing an
improvement of the current account also if the sum of demand elasticities is less than one, see e.g.
Pilbeam, Section 3.2.

Answer to question 6
Answer: 2.
Explanation:

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Initials: _______

 I is true, because unemployment and a deficit on the current account imply that the economy must
be below the full equilibrium point, so that a real depreciation is needed to achieve full
equilibrium, but that is impossible given the fixed real exchange rate.
 II is false, because joining the euro zone for instance fixes the nominal exchange rate, thereby
reducing the real exchange rate flexibility needed to achieve full equilibrium in the Swan diagram.

Answer to question 7
Answer: 3.
Explanation:
 I is wrong: if capital mobility is higher, Δr requires a larger ΔY to restore equilibrium (see one of
the slides on Chapter 4).
 The BP schedule is upward sloping (see e.g. the derivation in Pilbeam, p. 80), so II is correct.

Answer to question 8
Answer: 4.
Explanation: Answer 1 is correct, as relative PPP is less restrictive: if absolute PPP holds, then relative
PPP too. Answers 2 and 3 are also correct, see the slides on chapter 6. Answer 4 is false, as q must
equal zero for absolute PPP to hold, for relative PPP it is not restricted, which is also shown on the
slides.

Answer to question 9
Answer: 2.
Explanation:
 I is correct: The slides on chapter 8 show that the absence of exchange risk means that the real
appreciation is risk free, implying that the real exchange rate is perfectly predictable.
 II is false: Section 8.3 shows that inflation risk and exchange risk are two separate sources of risk,
and they can be nonzero at the same time.

Answer to question 10
Answer: 3.
Explanation: The market is not efficient if the forward rate systematically over- or under-predicts the
future spot rate, so 1 and 2 are false; see Section 9.2. Forex efficiency is about the average relation
between st+1 and ft, so that 4 is false.

Answer to question 11
Answer: 3.
Explanation: Answers 1, 2, and 4 are all correct. Answer 3 is totally wrong, it is an argument for
floating rates. See Sections 10.2 and 10.3 for details.
Note that answer 2 can also be used in favor of a floating exchange rate regime, but the very fact that
is can be used to support fixed rates makes it a correct answer.

Answer to question 12
Answer: 4.
Explanation: Answers 1 to 3 are indeed true, 4 is false – currency convertibility was not there for
capital account transactions to avoid destabilizing speculation. See the slides on chapter 11.

Answer to question 13
Answer: 2.
Explanation: The bipolar world assumption means that countries will choose either a hard peg (like a
currency board or monetary union) or a freely floating exchange rate. See Section 11.16. Even if

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students do not know precisely what the other regimes are, if they know the concept, it is clear that the
answer must be 2.

Answer to question 14
Answer: 1.
Explanation: See Section 14.4.

Answer to question 15
Answer: 3.
Explanation:
 The Delors report was on monetary integration, but it came out in 1989, so only several decades
after the Treaty of Paris of 1951. So I is false.
 II is true: see the slides on chapter 11.

Answer to question A (maximum number of points: 17; distribution across sub-questions:

17=3+6+1+2+5)
a) The exact version is 1+r = 1/S·(1+r*)·ES.
Here r (r*) denotes the domestic (foreign) interest rate, S is the exchange rate [domestic
currency units for one foreign currency unit], and ES is the expected future exchange rate.
b) UIP is an equilibrium condition on the foreign exchange market. It concerns two investments,
one at home (the Netherlands, say) and one abroad (U.S., say). Investing 1 euro in a Dutch bond
yields gross return 1+r at the end of the period. Investing the euro on the U.S. market first
requires a conversion of the euro into 1/S dollars. This yields 1/S(1+r*) dollars at the end of the
period. The expected value in terms of euros is 1/S(1+r*)ES. The behavior of speculators
ensures equality of both returns.
“Uncovered” means that exchange rate risk is involved (risk is not covered on the forward
market) and “interest parity” means that the domestic and foreign interest rates are equal (after
correction for expected exchange rate changes).
c) My home country is the Netherlands (or euro zone) and the reference country is the U.S.
d) The annual interest rates are about 4%, say, in both countries.
e) The home interest rate equals the foreign rate plus the expected depreciation of the home
currency plus a possible risk premium. The euro is roughly stable against the dollar, so the
expected depreciation term is about 0. Moreover, the risks of investing in the euro zone and the
U.S. are roughly equal, so that the risk premium is close to 0. These two facts explain why the
interest differential is close to 0.

Answer to question B (23=5+5+5+4+4)

a) Money market: m=p+ηy-σr and r is the equilibrating variable
International bond market: Es•=r-r* (UIP) and s is the equilibrating variable
Goods market: d=y, where d=β+α(s-p+p*)+φy, and p is the equilibrating variable.
Instead of giving the full formula for d, one could also write that d
depends on s-p+p* and y.
b) Start from a point on the MB curve; there md=ms and UIP holds. If p↓, then md↓: md<ms  to
restore money market equilibrium: r has to ↓  excess demand for foreign bonds  to restore
equilibrium on the international bond market Es• has to become negative: s has to increase.
Hence, the MB curve is downward sloping.
c) Start in a point (s,p) on the MB curve, so md=ms and UIP holds. Because y increases  md↑ 
to restore money market equilibrium money demand has to be decreased  for a given s that
means that p has to be lower (because that reduces money demand). By keeping s and r constant

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and because of the assumption that s- does not change, the bond market is also in equilibrium in
the new point. Hence, after the shock the money and bond market are in equilibrium in the new
point, so that point is on the new MB curve; the MB curve thus shifts downwards.
d) Start in a point (s,p) on the GG curve, so d=y. Because y increases  goods supply increases
more than goods demand  excess supply of goods  to restore equilibrium on the goods
market p has to be lower (for a given s), because that increases goods demand. Hence, the GG
curve shifts downwards.
e) Point A in the figure below gives the initial equilibrium. In the short term, p remains constant
(because of the assumption that prices are sticky in the Dornbusch model) and because the
money and bond markets are always in equilibrium, point B becomes relevant; the exchange
rate thus decreases a lot. In the medium run, p decreases because of the excess supply on the
goods market; s increases along the MB curve. In the long run, there is again simultaneous
equilibrium on all three markets (see point C): on balance p has decreased and s is at the initial
level.
p
GG
A
B

C MB

Answer to question C (14=4+5+5)

a) In the developing countries the interest rate was kept low to stimulate economic growth. This
led to high investment demand and low savings. The resulting excess demand for funds was
resolved by an inflow of foreign capital.
b) Due to the two oil crises in the seventies, oil-exporting countries had large current account
surpluses. The oil dollars were partly deposited at non-American banks. Those eurobanks used
the oil dollars to provide dollar loans to the developing countries. The foreign debt position of
those countries worsened substantially, which was one of the reasons for the debt crisis.
c) Because of the dollar appreciation and the dollar denomination of the foreign debt of the
developing countries, their debt measured in domestic currency (numerator of ratio) increased.
In addition, (the growth of) their exports decreased due to the stagnation of the world economy
and the strong sensitivity of their exports (most primary inputs used for the production in other
countries) to the business cycle, so the denominator of the ratio decreased. Hence the total ratio
increased.

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