Nov-10 Dubai, End Term Exam

MFP – 1 (Prof. / Dr Mankad) (Nov, 10-11 Dubai batch)

Question 1 (40 Marks)

Pick any article / section / advertisement from FT (not older than 1-2 days) and write a note on it (your own observations) for at least 2 pages.

Question 2 (24 Marks)

Two days before the exam, a hypothetical situation related to American election in 2020 arising out present day complex economic problem in the US has been given to you. Based on the given scenarios, please answer the following question –

1. What may happen from now till November 2020 that may bring the hypothetical situation described or something similar to it become reality?

2. What needs to be done to ensure that such a situation does not arise?

You may, if you desire, answer both the questions together in a single composite response.

Please note that assessment of your response will be made in totality and not question wise.

(Evaluation criterion: Superior response: 16 + marks, Average response 9-15 marks, poor and / or sketchy response less than 9 marks)

Question 3 (36 Marks)

Explain at length any four of the following statements. Your explanation needs to cover the meaning as well as context of the statement. Many practical examples will enrich your response.

1. Changing demographic is raising many macroeconomic issues globally

2. In present context, China’s economic growth is a blessing as well as a curse

3. Study of the Macroeconomic is study of imbalances in the world

4. Inflation is unjust, unemployment is undesirable

5. Gold Standard was not workable in the post first world war period

6. Global balance of payments is always in balance. If some countries have deficits, it is because some other countries have surplus

7. Making US dollar the reserve currency at Bretton Woods required obligations on part of America which it failed to keep.

8. Expectations shape macroeconomic outcomes

(Evaluation criterion: Superior response: 7 + marks, Average response 4-6 marks, poor and / or sketchy response less than 4 marks)

Birth of Euro due to German Unification

Ø Scenario in Germany

a. 1991 – German Unification

b. Newly formed Germany went into major FISCAL EXPANSION (increased Government spending) after unification to revamp infrastructure of East Germany

c. East German Marc became relevant and East German went to West for purchase of Goods, which increased the demand of goods in Germany.

d. Hence, overall demand in Germany was boosted (From Points 2 & 3) which resulted in inflation to rise.

e. Germans are obsessed with price stability. Hence, German central bank sucked out liquidity from the economy (MONETORY POLICY CONTRACTION) to lower the inflation and hence, increased interest rate

f. Europe was bound together by ERM (Exchange Rate Mechanism), where West German Deutsche Mark was fluctuating vis-à-vis other hard currency of the world. Rest EU currencies were pegged to Deutsche Marc (Range of +-2.25)

g. Because of High Interest rate in Germany, Deutsche Mark was in demand and everyone was dumping the other currency

Ø Scenario in UK

a. To maintain the peg, UK started buying their own currency from their domestic market to increase its demand, in exchange of Deutsche Mark from their reserves (to avoid further weakening of UK pound)

b. The above resulted in sucking of liquidity (pound) from UK market, thereby increasing the interest rate (MONETORY POLICY CONTRACTION)

c. SEPTEMBER 16, 1992 – Speculator George Soros knew that this process can’t continue & hence, he started buying Deutsche Mark ($10 billion) by selling British pound (Government was buying pound at a relatively high price).

d. But at a certain point, Bank of England didn’t had enough Mark to sell to Soros. Finally, they announced that they can’t maintain the peg because

i. They were out of reserve of Deutsche Mark

ii. UK needed low interest rate, but pegging meant high interest rate

e. Result – $ 1 billion USD in profit for George Soros, UK came out of ERM

Ø How to avoid such speculation in future

a. Have flexible exchange rate – But EU wanted to have fixed / pegged currency in order to promote peace through economic stability, cooperation and inter-dependence (to avoid one more WW II)

b. Have single currency – EURO was born a little early

Ø EURO was born - Hence, it represents early birth of EURO, united monetory policy, but no unified fiscal policy