Deck 17: Balance of Payments I: the Gains From Financial Globalization

Question 1

Which of the following is the value of a country's external wealth at the end of 2016 if its external wealth was $1 billion at the end of 2015 and its trade balance was $500 million in 2016? Assume the world interest rate is 10% per annum.

A) $1.5 billion
B) $1.6 billion
C) $0.5 billion
D) $0.6 billion

Answer 1

B

Question 2

Which of the following is NOT an assumption belonging to the long-run budget constraint model?

A) The government has a balanced budget.
B) Prices are perfectly flexible.
C) The economy is a price taker, small, and open.
D) The economy can borrow or lend unlimited amounts at the world real interest rate.

Answer 2

A

Question 3

The notion that a country must live within its means, thus determining the amount a country can borrow, is known as the:

A) short-run trade-off.
B) resource allocation rule.
C) long-run budget constraint.
D) law of reciprocity.

Answer 3

C

Question 4

Continually rolling the interest on a loan over into the principal is called:

A) a budget surplus.
B) a Ponzi game.
C) the intertemporal approach.
D) macroeconomics.

Question 5

Suppose that a country has external wealth of $1 billion in 2014. What is the future value of this external wealth at the end of 2016, assuming a world interest rate of 10% per annum and no additions or subtractions to external wealth from trade balance surpluses or deficits during the period?

A) $1.1 billion
B) $1.2 billion
C) $1.21 billion
D) $0.812 billion

Question 6

International borrowing and lending involve changes in:

A) the price level.
B) the interest rate.
C) the levels of external wealth.
D) the stock of gold owned by a nation at a particular time.

Question 7

A nation's use of international capital markets enables it to do all of the following, EXCEPT:

A) provide for a higher level of national defense.
B) smooth consumption over time.
C) build a productive national capital stock.
D) reduce risk through diversification.

Question 8

A country has $50 million of debt at the rate of 10%. It does not make any payments in year 1 and manages to renegotiate the interest rate to 5% at the end of year 1. The interest payment in year 2 for this country would be:

A) $57.75 million.
B) $7.75 million.
C) $5 million.
D) $2.75 million.

Question 9

When disaster strikes a country and destroys infrastructure and businesses, it is likely that:

A) savings will decline and the current account will move into a surplus.
B) the current account will move into a deficit.
C) investment will decline.
D) savings will decline and the current account will move into a deficit.

Question 10

When a disaster destroys a family's home, the family can make use of all the following solutions, EXCEPT:

A) accept gifts or donations from friends.
B) accept gifts or donations from charitable organizations.
C) apply for a loan or seek insurance payouts.
D) take over the next undamaged property in the vicinity.

Question 11

A nation's net income from interest is:

A) the domestic interest rate minus the world interest rate.
B) the world interest rate times external assets.
C) the world interest rate times external liabilities.
D) the world interest rate times external wealth.

Question 12

If a country has a $100 million debt and the interest rate on the debt is 5% and the debt is serviced each year, this would result in:

A) an interest payment of $5 million and a reduction in the debt amount by $10 million each year.
B) an interest payment of $15 million and a reduction in the debt amount by $10 million each year.
C) an interest payment of $5 million and no change in the debt amount.
D) an interest payment of $1 million and an increase in the debt amount by $10 million each year.

Question 13

If a nation has a balanced current account and its net external wealth is positive:

A) it is a net debtor and payment flows are negative.
B) it is a net creditor and payment flows are positive.
C) it is in balance and its payment flows are zero.
D) it has liabilities greater than assets.

Question 14

There is a limit to a nation's ability to use international financial markets to supplement domestic consumption or investment. Why?

A) Lenders like a diversified group of borrowers.
B) International lenders require collateral.
C) Communication is difficult because of language and differences in legal systems.
D) At some point, a nation will not be able to service the rising level of external debt.

Question 15

In theory, financially open economies can:

A) manipulate their trade accounts to avoid imbalances.
B) avoid all economic shocks or downturns.
C) lower the unemployment rate but cannot control inflation.
D) use access to the international financial markets to keep investment and consumption stable.

Question 16

If a country has $100 million of debt, the interest rate on the debt is 10%, and the country does not make any payments on the debt, then at the end of year 3, the debt amount would be:

A) $121 million.
B) $110 million.
C) $133.1 million.
D) $100 million.

Question 17

For the three years after a severe economic shock such as that caused by a hurricane, typically:

A) nations enjoy higher consumption.
B) creditors become impatient for debtors to begin their payback.
C) investment rises and saving falls; the current account deficit rises, financed by financial inflows.
D) domestic financial markets are able to handle the situation without a decrease in consumption.

Question 18

Which of the following is the value of a country's external wealth at the end of 2016 if its external wealth was -$1 billion at the end of 2015 and its trade balance was $500 million in 2016? Assume the world interest rate is 10% per annum.

A) -$1.5 billion
B) -$1.6 billion
C) -$0.6 billion
D) -$0.4 billion

Question 19

The change in external wealth from period N - 1 to N is equal to:

A) the balance on the current account minus the balance on the financial account (FA).
B) the trade balance (deficit or surplus) plus interest (earned or paid) on external debt or wealth.
C) a nation's domestic income plus net foreign factor income.
D) the balance on the current account plus the balance on the capital account.

Question 20

In a two-period case, a country's present value of _____ from year 1 should be equal to the present value of _______.

A) trade balance; trade balances of the next two years
B) wealth; trade balances for the next four years
C) wealth; trade balances for the next two years
D) trade balance; wealth for the next two years

Question 21

If you are scheduled to receive a $10,000 payment in two years and the interest rate is 10%, then the present value of this payment is:

A) $9,000.
B) $8,264.
C) $12,000.
D) $5,000.

Question 22

The long-run budget constraint indicates that, in the long run, a country's initial external wealth must be offset by (i.e., equal to):

A) the present value of its future trade balances.
B) the future value of its future trade balances.
C) the current value of its future trade balances.
D) the present value of its future external wealth.

Question 23

What is the present value of annual payments of $1,000 received in perpetuity (i.e., forever) if the world interest rate is 6%?

A) $16,667
B) $1,060
C) $6,000
D) $60

Question 24

The United States has been experiencing trade deficits on the order of $600 billion to $800 billion during the past several years. Which of the following is an implication of these trade deficits?

A) U.S. GDP has been larger than U.S. GNE.
B) U.S. GDP has been smaller than U.S. GNE.
C) U.S. net external wealth has been increasing.
D) U.S. exports are greater than U.S. imports.

Question 25

What is the present value of a nation's net external wealth?

A) It is gold, plus outstanding currency, plus foreign currency reserves in the nation.
B) It is the present and future real GDP discounted to present value.
C) It is the average real income per capita times the average work span times the rate of economic growth.
D) It is the sum (discounted to the present) of future trade deficits or surpluses.

Question 26

The present value of an infinite stream of payments (X) at an interest rate of r% (r^*) is calculated as:

A) X - r^*.
B) X + r^*.
C) X × r^*.
D) X ÷ r^*.

Question 27

The present discounted value of an infinite stream of payments of $5 per year when the interest rate is 20% is:

A)

Question 28

The present discounted value of an infinite stream of payments of $1 per year when the interest rate is 10% is:

A) 0.909.
B)

Question 29

The present value of a perpetual loan, for which only outstanding interest is paid (no principal), is equal to:

A) the principal.
B) the sum of future interest payments, which is infinity.
C) zero.
D) It depends on the rate of interest, which is also the rate of discount.

Question 30

If the United States is currently a net international debtor, then:

A) it has negative net international wealth.
B) it has positive net international wealth.
C) it must run trade deficits to eliminate its net international debt.
D) it must borrow internationally to eliminate its net international debt.

Question 31

The two-period budget constraint tells us:

A) a creditor country can afford future deficits "on average."
B) a creditor country cannot afford future deficits "on average."
C) a debtor country cannot afford future deficits "on average."
D) a debtor country can afford future deficits "on average."

Question 32

The long-run budget constraint says that:

A) a country will be able to borrow in perpetuity.
B) a country will have to always balance its budget in the short-run.
C) a country's expenditure must equal its production.
D) a country's expenditure can be higher than its production.

Question 33

If a nation's yearly trade balance exactly offsets the interest due on its net external wealth, what is the effect on its net external wealth?

A) It remains the same.
B) It explodes.
C) It declines at first and then rises dramatically.
D) It rises gradually because of interest compounding.

Question 34

Suppose that the present discounted value of a stream of payments is $1,000. If the yearly payment is $50, what is the interest rate?

A) 50%
B) 20%
C) 5%
D) 0.5%

Question 35

Suppose that the present discounted value of a stream of payments is $1,000. If the interest rate is 10%, what is the constant payment per year?

A) 100
B) 10
C) 1
D) 1,000

Question 36

What happens if the trade balance is in surplus by more than a nation's service payments on its external debt?

A) The nation's net external wealth declines.
B) The nation's net external wealth increases.
C) The nation's net external wealth is constant.
D) The nation must run a trade deficit during the subsequent period.

Question 37

The long-run budget constraint for a nation is:

A) GDP minus taxes to run the government.
B) equal to GDP divided by the population.
C) the level of external debt, offset by the sum of the present value of future trade surpluses taken to infinity.
D) determined by its ability to lure international investment and capital inflows.

Question 38

Suppose that the present discounted value of a stream of payments is $200. If the yearly payment is $10, what is the interest rate?

A) 50%
B) 20%
C) 5%
D) 0.5%

Question 39

Because the trade balance is the difference between GDP and GNE, the long-run budget constraint for a nation becomes:

A) its initial wealth minus depreciation plus investment.
B) the present value of: the sum of its GDP, minus its GNE, plus its initial external wealth (or minus its initial debt).
C) the value of real assets plus foreign currency reserves plus new investment.
D) the present value of domestic production of capital goods plus exports.

Question 40

The long-run budget constraint dictates that:

A) the present value of trade balances is zero taken to infinity.
B) the present value of wealth is equal to zero taken to infinity.
C) the present value of wealth is exactly offset by the present value of trade balances.
D) if the present value of wealth is positive, the nation cannot afford future trade deficits on average.

Question 41

The key lesson from the LRBC model is:

A) nations can safely run trade deficits as long as they can cover the interest each year.
B) nations must balance their current account year by year.
C) nations must maintain a balance between the present value of deficits and the present value of surpluses that satisfy the LRBC.
D) nations may lend externally but it is dangerous to borrow.

Question 42

In the case of the United States, the long-run budget constraint is eased somewhat by:

A) increasing debt and increasing wealth at the same time.
B) figuring in the capital gain differential and an interest rate differential on external assets and liabilities.
C) the surprising shrinking trade deficit of the United States.
D) the shrinkage of the U.S. national debt.

Question 43

The long-run budget constraint will be met as long as:

A) a nation limits its borrowing to half the outstanding debt.
B) the present value of GDP is the same as the present value of yearly consumption.
C) a nation's productivity grows along with its population.
D) the government is stable and external shocks are minimal.

Question 44

The United States has experienced a favorable situation in world financial markets. What is it?

A) The United States has huge net external wealth and is able to control many foreign corporations, banks, and governments as a result.
B) Even though the United States has huge net external debt, it has benefited from a 1.5% gain in interest differential and an additional 2% capital gain on its net debt/wealth.
C) Other nations deposit their funds in U.S. banks, making them available for U.S. borrowers.
D) Politically the United States is very powerful, and most international financial organizations want good relationships with it, making financial dealings more favorable to the United States.

Question 45

If you prefer to smooth consumption, which of the following would you prefer?

A) $100 of consumption today and $50 of consumption tomorrow
B) $75 of consumption today and $75 of consumption tomorrow
C) $50 of consumption today and $100 of consumption tomorrow
D) You would be indifferent between all of these.

Question 46

The risk premium associated with a government loan:

A) rises with national debt.
B) is independent of national debt.
C) falls with national debt.
D) is unrelated to government bond ratings.

Question 47

Economists say the United States has a favorable interest differential because:

A) interest that the U.S. government pays on Treasury debt is unusually low.
B) returns on foreign portfolio investment in the United States are low.
C) returns on foreign portfolio investment in the United States are high.
D) returns on U.S. international investments are unusually high.

Question 48

The exorbitant privilege for the United States implies that:

A) the United States can lend money to people at low interest rates.
B) U.S. investments abroad often earn very low interest rates.
C) foreigners' investments in the United States earn them less income than the U.S. investments abroad.
D) foreigners' investments in the United States earn them more income than the U.S. investments abroad.

Question 49

What is a sudden stop?

A) a situation in which a nation runs out of labor resources
B) a situation in which a nation's prime minister has to call a new election
C) a situation in which a nation's financial markets collapse and investors lose everything
D) a situation in which a nation's creditors decide to cease new lending

Question 50

The LRBC dictates that if initial wealth equals zero:

A) present value of GDP (Q) = present value of C (GNE).
B) present value of GDP (Q) = present value of TB.
C) present value of TB = present value of C (GNE).
D) present value of TB = 0 = present value of GDP (Q) - present value of C (GNE).

Question 51

A sudden stop in credit availability:

A) is usually manageable if the nation has sufficient reserves to cover imports.
B) is usually very disruptive and necessitates major cuts in expenditures.
C) affects large industrial nations primarily.
D) is very unlikely to happen in practice.

Question 52

In the absence of consumption smoothing, the following are possible:

A) income and consumption are balanced yearly, and consumption does not fluctuate with income.
B) consumption fluctuates with income.
C) consumption does not have to change as income changes.
D) income and consumption are balanced yearly, and consumption fluctuates with income.

Question 53

The assumption of a nation's ability to borrow or lend any amount it chooses is:

A) always true.
B) never true.
C) true only for nations with advanced industrial economies and good credit ratings.
D) true for emerging economies due to their high returns on investment.

Question 54

Assuming investment (I) and government purchases (G) are zero, then the basic model of an open economy (where C = consumer spending; S = saving; T = taxes; X - M = exports - imports; and Q = GDP) is:

A) C + I + G = Q.
B) I = S.
C) I + S = G + T.
D) Q - C = X - M.

Question 55

The effect on a country's consumption as a result of a permanent shock is:

A) that consumption smoothing is not possible.
B) a temporary change in consumption.
C) a permanent change in consumption.
D) that consumption smoothing is not possible and there is a permanent change in consumption.

Question 56

Most experts believe that the favorable U.S. situation in world financial markets:

A) could be transferred to other nations if they could get their economies in order.
B) is actually even better than it appears because of the robust nature of the U.S. economy.
C) may be exaggerated because of faulty statistics, and the U.S. net external debt may be even larger.
D) is a direct result of the expertise of the Federal Reserve and the U.S. Treasury.

Question 57

In low-income nations, the budget constraint is usually:

A) more lenient because creditor nations are interested in helping poor countries grow.
B) more stringent because poor nations have low credit ratings and pay higher rates of interest.
C) ignored by international financial markets.
D) good for these nations because they should not get into debt they are unable to repay.

Question 58

The intertemporal model is NOT used in determining which of the following?

A) how yearly international imbalances affect the long-run wealth or debt of a nation
B) how a nation must borrow each year the difference between payments to the rest of the world and income from the rest of the world
C) how a nation's external debt can grow to unsustainable levels as a result of persistent imbalances
D) how a nation must save each year the amount equal to the difference between payments to the rest of the world and income from the rest of the world

Question 59

An assumption of the intertemporal model that is often not met in low-income nations is:

A) that the economy is always at full employment.
B) that prices are flexible.
C) that a nation can borrow or lend any amount in international markets at the prevailing world real rate of interest.
D) that the government of the nation has a balanced budget.

Question 60

The present value of GDP:

A) equals GNE.
B) equals GNE only when the country begins with positive initial wealth.
C) equals GNE only when the country begins with negative initial wealth.
D) plus the present value of initial wealth must equal the present value of GNE.

Question 61

Which of the following methods can a country use to accumulate precautionary savings?

A) an increase in taxes
B) a reduction of government expenses
C) an accumulation of foreign exchange reserves by central banks
D) a reduction in unemployment benefits

Question 62

In an open economy, as long as the long-run budget constraint is upheld, a nation may:

A) run a trade deficit during temporary shocks and run a trade surplus during temporary gains in output, keeping consumption stable.
B) save during temporary shocks and borrow during temporary gains.
C) forgo borrowing to maintain financial stability, allowing consumption to fluctuate.
D) save even if it is just a little during each period.

Question 63

If the percentage of change in total spending (C +

A) financial autonomy.
B) consumption smoothing.
C) imminent recession.
D) prosperity.
G) is lower than the percentage change in income, an economy has some degree of:

Question 64

Events such as wars not financed by increases in taxes, such as the U.S. Afghanistan and Iraq wars:

A) usually involve international borrowing and an increase in external debt.
B) can be paid for by transfers and gifts from sympathetic allies.
C) can be financed by increasing discount operations, thereby avoiding tax increases.
D) add to the instability of the international economy and create large spikes in GDP growth.

Question 65

When there is a temporary shock to output (positive or negative), what happens to consumption in an open economy?

A) It is unchanged.
B) It changes by exactly the same amount as output.
C) It changes by more than the temporary output gain or loss by a factor of (1 + r^*) / r^*.
D) It changes by less than the temporary output gain or loss by a factor of r^* / (1 + r^*).

Question 66

If a nation experiences an output shock and wishes to borrow to smooth consumption, how much of the loss is the nation able to borrow and still maintain the long-run budget constraint?

A) 100% of the output shock
B) 20% of the output shock
C) a percentage of the shock to GDP equal to 1/(1 + r^*), where r^* is the world long-run real interest rate
D) A nation in such a position is better off not to borrow because it might get into financial trouble.

Question 67

Sovereign wealth funds are created for all of the following reasons, EXCEPT:

A) to get a better return on their assets.
B) to save the windfall from natural resource exports.
C) to discourage foreign investment in the domestic economy.
D) to invest bank reserves and state revenue/savings.

Question 68

International firms have begun to offer a new product based on the need for nations to put their savings into productive and high-return assets. It is called:

A) external wealth funds.
B) sovereign wealth funds.
C) automatic withdrawals.
D) sovereign debt accounts.

Question 69

A nation that engages in precautionary savings is:

A) putting away money for the children of baby boomers who will enter college in the next decade.
B) storing foreign currency reserves, bonds, or deposits to use in case of persistent deficits.
C) forgetting that saving cannot save an economy from poverty-it takes investment.
D) holding back pay of top government officials to make them accountable for their actions.

Question 70

If a nation experiences an output shock and wishes to borrow to smooth consumption, how much of consumer spending must it forgo each year to achieve consumption smoothing and maintain the long-run budget constraint?

A) an amount equal to r^*/(1 + r^*) of the output shock
B) an amount equal to 20% of its output shock
C) 95% of the output shock
D) an amount equal to r^* as a percent of the former level of GDP

Question 71

In an open economy, in the long run, permanent shocks to GDP:

A) are always contentious during an election year.
B) are rare, but cannot be ignored.
C) must be dealt with by permanent changes in consumption.
D) indicate that taxes need to be raised.

Question 72

If, in an open economy with a real world interest rate of 5%, an output shock (decline) of 21% occurs followed by a recovery the next year:

A) no consumption smoothing is possible.
B) the nation can borrow 20% of GDP in the first year and repay 1% of GDP each year in perpetuity resulting in consumption smoothing.
C) then no borrowing is possible because of the possibility of exceeding the long-run budget constraint.
D) the economy would have to forswear all international trade and financial flows.

Question 73

An open economy has:

A) greater ability to smooth its consumption because of the absence of domestic shocks.
B) greater ability to smooth its consumption because of the ability to borrow internationally.
C) less ability to smooth its consumption because of the lower marginal product of capital.
D) less ability to smooth its consumption to weak links present in the financial system.

Question 74

In a closed economy, what happens to the present value of GDP (discounted at 5%) following an output shock (decline) of 21% recovered the following year?

A) There is a permanent drop of 1% in the present value of GDP.
B) There is no long-run effect on present value.
C) There is a 1-year drop of 1% in GDP the first year followed by full recovery.
D) There is a downward spiral in real GDP resulting in a permanent drop of 21%.

Question 75

If an economy is closed and has no internal shocks, its consumption will:

A) be perfectly smooth.
B) be erratic depending on consumer tastes.
C) be constrained because households have no means to borrow for large purchases.
D) decline as equipment and machinery depreciate.

Question 76

If low-income nations purchase sovereign wealth funds, in effect they are:

A) providing scarce investment funds to other nations, causing a transfer from poor to rich.
B) increasing the risk of default.
C) just delaying the inevitable drop in consumption.
D) treating corporations as tools of government policy.

Question 77

Low-income nations with poor credit ratings are often dependent on commodity sales as a major portion of income. To insure against the effects of a fall in the prices of commodities, the nation could:

A) borrow internationally.
B) save as a precaution and purchase sovereign wealth funds with that money.
C) ask for debt reduction and forgiveness.
D) enter into a cartel to boost the prices of commodities.

Question 78

Consumption smoothing is possible as long as the output shock is:

A) temporary.
B) permanent.
C) less than 10%.
D) more than the rate of interest.

Question 79

Which of the following statements is NOT correct?

A) Many poor nations have backward financial markets, giving the public no access to foreign investments.
B) Financial markets offer little security and government regulation in poor nations.
C) In many poor nations, few people are rich enough to save, and there is capital flight.
D) Poor nations benefit greatly from globalization through the use of foreign investments.

Question 80

If the United States were a closed instead of an open economy, the economic effects of the Iraq War would be felt:

A) more by U.S. consumers.
B) by trading partners with the United States.
C) less by U.S. consumers.
D) by the world.