ECON 3H03 McMaster University International Monetary Economics Questions Question example:1. Using the model of contingent commitment, show how a simulttan

ECON 3H03 McMaster University International Monetary Economics Questions Question example:1. Using the model of contingent commitment, show how a simulttaneous devaluation and rise in the risk premium could lead to a scenario2. Prio to breaking the peg, the Mexican central bank issued dollar denominated debt, which it used to buy Mexican pesos. What would you expect the impack of this type of transaction to be on M, R, B for the central bank’s balance sheet? To backing ratio? ECON 3H03 Final Exam – Take Home Question
There are two options for the take home question. Each student must answer one of
them. No more than one submission will be graded.
Directions: Students may work together to answer these questions but must submit their own
written responses. Any two or more identical submissions will all receive a grade of zero.
Answers may be handwritten or typed, but they must be submitted in a single PDF document
no more than two pages in length. Submissions with more than one document or exceeding
two pages will receive a grade of zero. All data obtained must be included in submissions so I
can verify it. Answers without data attached receive zero credit.
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Question 1
In 1994 the Mexican government abandoned their crawling peg to the US dollar. This was
brought about by a complicated sequence of events, but in this question we focus only on the
dynamics of the last part of the crisis. Running low on dollar reserves in December of 1994,
the Mexican central bank devalued the peso. However, unlike in our discussions in class, this
devaluation was not credible – there was a spike in the risk premium investors demanded to
lend to Mexico. The resulting increase in interest rates and contracting output ultimately led
the government to abandon the peg.
(1) Using the model of contingent commitment in Chapter 9, show how a simultaneous
devaluation and rise in the risk premium could lead to a scenario such as the one described
above.
(2) Prior to breaking the peg, the Mexican central bank issued dollar denominated debt, which it
used to buy Mexican pesos. What would you expect the impact of this type of transaction to
be on M, R, B for the central bank’s balance sheet? To the backing ratio?
(3) Obtaining current data on at least two different variables, make the best argument you can
for why Mexico should unilaterally peg to the US dollar again.
Question 2
Oil is an international commodity, whose price Canada takes as given. Starting around
mid-2013 crude oil prices fell fairly quickly, stabilizing in mid-2015. Around the same period of
time, the Canadian dollar depreciated relative to the US dollar.
(1) Use the IS-LM-FX model to explain why a decline in oil prices might lead to a depreciation of
the Canadian currency.
(2) As a Central Banker what would you do to counteract this impact? Using your answer from
part (1), what should happen to interest rates after the decline in oil prices? Obtain historical
data on the Bank of Canada’s benchmark interest rate. Does the bank’s action appear
consistent with your own recommendation?
(3) Oil prices have currently plummeted due to a price war between Saudi Arabia and Russia.
Obtain recent data on the CAD/US exchange rate and compare it to your IS-LM-FX
predictions from part (1). Has it behaved in the way that you would expect? Why or why
not? Of the models we have studied, is IS-LM-FX the right model to use to think about this
question? Why or why not? If not, what is a better theory we have studied?

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