Global Economic History Mid-Term Exam PDF - Practice, A-K

ECN 110B: Global Economic History PROFESSOR CHRISTOPHER MEISSNER PRACTICE MID-TERM EXAMINATION I SUGGESTED ANSWERS This exam has two sections. It is shorter than the actual mid-term which will have 10multiple choice questions. Section 1 Multiple Choice 1.All of the following except one would be indi...

ECN 110B: Global Economic History PROFESSOR CHRISTOPHER MEISSNER PRACTICE MID-TERM EXAMINATION I SUGGESTED ANSWERS This exam has two sections. It is shorter than the actual mid-term which will have 10multiple choice questions. Section 1 Multiple Choice 1.All of the following except one would be indicative of higher integration a. lower tariffs b. interest rates of a country converge to those of global capital markets. c. lower insurance costs d. a rise in the number of skilled workers e. faster shipping times 2. According to Adam Smith, one way greater opportunities for trade promotes productivity advance is a. b. c. d. e. Greater investment in pirating and privateering specialization by limiting the power of dictators lowering income inequality because fixed exchange rates are not possible if you want to trade 1 3. Which of the following was not a crucial factor in explaining the migration patterns of free workers in Europe prior to 1914 a. information and personal connections b. credit constraints c. government restrictions that limited entry to specific nationalities d. population pressures in the sending country e. wages in the receiving and sending countries 4. Which of the following did the least to promote free and open immigration into the United States? (a) Falling shipping costs (b) The Chinese Exclusion Act of 1882. (c) Famine and hunger in Europe. (d) Good information on job opportunities in the US from previous migrants (e) An economic boom in the US 5. An indicator that capital markets were internationally integrated between 1850 and 1913 is a. Real interest rates gaps between countries persisted b. Bond yield movements were highly correlated between various country pairs c. Savings equaled investment in most economies d. The marginal product of capital diverged e. Exchange rates were fixed 6. When nations signed a trade treaty with a Most Favored Nation clause: a. b. c. d. They made tariffs for the two countries as high as possible. Diplomatic relations increased. Immigration between two nations was liberalized. Both nations now had to extend their lowest tariff on all goods with their treaty partner. e. Capital flows were liberalized. 2 7. The principle cause of hyperinflation in places like Germany between the wars is likely to be a. Commodity price shocks b. High growth in GDP per capita and “overheating” of the economy c. Reparations payments and government budget deficits d. Nominal rigidities e. Expectations of lower growth 8. The gold standard in the period between the two world wars was weak when compared to the gold standard prior to World War I because of which of the following a. b. c. d. e. The loss of British leadership at the international level Lack of paper money Controls on capital flows Immigration Nations could not commit to play by the rules of the game and nations could not borrow gold in times of crisis from other countries Section 2 Short Answer Questions Directions to the short answer section. Please give brief answers within the space given to these questions on this exam. Keep your answers concise! 1. If countries faced a trade deficit why did the gold standard “rules of the game” say that such a country had to raise interest rates and lower prices? Was this easy to do or not? What implication does this have for an economy’s choice of exchange rate policy? A country with a trade deficit is losing gold to pay for the deficit. The price-specie flow mechanism says that this will cause the money supply to fall and thus prices will fall. When price fall then exports can rise since they will be cheaper on world markets. This will allow the country to have a surplus and to gain gold that it lost during its deficit period. The rules of the game suggest that this country raise interest rates. Higher interest rates may attract capital and thus “pay for” the trade deficit. (Technically the rules of the game suggest that when gold and foreign exchange reserves rise the central bank act and buy 3 more domestic bonds and when gold reserves are in decline that the central bank sell domestic bonds. In this way the rules imply that a central bank magnify the impact of changes in reserves on the money supply. Note: the money supply is determined by the sum of gold, foreign reserves and domestic bonds held at the central bank) Prior to World War I leading nations like the US, France, Germany and Great Britain usually could count on capital to fill in the lost gold during a deficit. We argued also that in the short run a country could count on this credibility to play by the rules of the game in the long run and even cooperation if needed to keep from having to raise interest rates or sell more exports to gain gold. In the long run these countries would play by the rules of the game if capital did not come to the country based on “credibility”. This would cause the money supply to fall, investment to fall and consumption to fall. This will be an induced recession. Prices and wages will also fall. It is likely that before wages fall prices will fall causing some unemployment. As wages and prices fall, exports can rise since they will be cheaper on world markets. This will allow the country to have a surplus and to gain gold that it lost during its deficit period. For these countries they were able to maintain their fixed exchange rate and benefit from increased trade and capital flows. But in the long-run they might have had to endure some economic pain to maintain the gold standard. However many smaller poorer nations had floating exchange rates: Greece, Italy after the 1880s, Argentina between 1890 and 1903, Brazil, Portugal after 1890, Austria throughout etc etc. They had some control over their interest rates and their monetary policy. They did not have to play by the rules of the game because doing so did not have an effect. Higher interest rates did not attract capital flows and they had little credibility. Most countries instead printed lots of money in the case of a deficit which usually made their currencies fall in value against the currency of Great Britain. Instead of having a fixed exchange rate their exchange rates fluctuated. These countries had lower trade and capital flows as a consequence of not being able to play by the rules of the game and by “floating”. However they did not necessarily have to induce a recession to deal with a trade deficit. For them the benefits of the fixed/pegged exchange rate/gold standard seem to have been lower than avoiding the recessions they needed to have to deal with trade deficits. 4 2. How do we measure economic integration and globalization in this class? Discuss the changes in the level of globalization over time between 1850 and present. Choose one area of analysis (trade, capital flows or migration) and one of the following 3 periods: 1850-1914, 1920-1938 or 1950-2020. What factors drove the changes in globalization the chosen area and period. Example answer. In this class three measures we used are the ratio of exports to GDP, ratio of international assets to world GDP or share of the foreign born in the population. Looking at trade 1850-1914 we see a rise in this ratio. Prior to this period the ratio had stayed low and constant. With changes in technologies and policies the ratio began to rise heralding the first wave of globalization. Trade costs declined a lot! What are some examples of declines in trade costs? Trade treaties, the steam ship, the telegraph, fixed exchange rates, better access to trade finance through London, Empire, etc. Each of these trade cost declines has its own story and implications for the gains from integration. 5 3. This question is about the gold standard and the Great Depression a. What key vulnerabilities existed in the gold exchange standard in the 1920s? (3 sentences max.) countries lacked credibility countries did not cooperate countries backed their currencies with foreign exchange reserves that were in turn convertible to gold since there was not enough gold to back all currencies. Foreign exchange reserves are only credible if the country issuing them is credible. Some countries did not play by the rules of the game. France especially allowed a large surplus to continue and instead of lowering interest rates, allowing the money supply to increase and prices to rise it “sterilized” gold inflows. It amassed a huge share of global gold in the late 1920s. b. If nations lack credibility to maintain the gold standard: what do capital markets do to them and what do nations have to do to convince markets they have credibility? Give an example of country that lacked credibility in the 1930s. How did this affect the exchange rate policy of this country in the short and long-run? (4-5sentences max.) If a nation lacks credibility markets might expect a larger depreciation or a higher probability of a depreciation –investors will need to be “compensated” with higher interest rates. (This is related to the covered interest parity condition r* = r + [E(e)-e]. In order to have an equilibrium if E(e) goes up, then nations must raise interest rates to attract capital and gold - otherwise their gold reserves will be exhausted and they will be forced off the gold standard. In 1931 it was questionable whether Britain would stay on the gold standard. They were not enthusiastic about raising interest rates in response to the banking crisis that started in Austria and spread to Germany. Eventually people began withdrawing gold from Britain and put the gold standard in jeopardy. First the response was to raise interest rates and borrow from the US. They could not borrow too much though and they decided to limit the rise in interest rates. Eventually they went off the gold standard in September 1931 causing a depreciation in the pound sterling relative to other gold countries. c. If nations had cooperated in the 1930s like they had prior to World War I how would this have helped them maintain the gold standard between 1929 and 1933? (4 sentences max.) How would monetary policy coordination have helped limit how deep the Great Depression was? If a currency is under threat then markets are demanding gold in exchange for the currency. Markets act like people in a bank panic. If nations could borrow gold and reserves from other central banks they could calm the panic and stay on the gold 6 standard. If all nations had lowered interest rates, say in 1930, then no one country would have lost gold or capital and at the same time they could have expanded the money supply, raised prices (together! Remember the exchange rate equals the ratio of the price levels. For the US and Britain we would have Price Level in the USA = ($/Pound)*Price level in Great Britain), stopped deflations and made a recovery. d. At the start of the downturn that became the Great Depression, many nations had fixed exchange rates via the gold standard, free capital flows. What would they have liked to do what with their monetary policy to stabilize output or to keep GDP from going down in say in 1929 and 1930? Would this be possible? What policy change could help escape from the Great Depression in this case. (one paragraph max.) They would have liked to lower interest rates or equivalently raise the money supply and hence prices. But you cannot do this if you do not have control over the interest rate as per the – see the interest parity condition. Usually nations were forced to raise rates since markets tried attacking currencies or grew skeptical currencies would keep their pegs. making for further interest rate rises. This was too much deflation and depression to handle for many countries and so countries abandoned the gold standard and the commitment to fixed exchange rates. Going off the gold standard and depreciating helped in many ways: 1) Boosting exports 2) Raising the price level and lowering the real value of debts 3) Raising the price level and lowering the real wage – making hiring of workers easier and more profitable. With more employment there would be more output and more output per person. 4) Lowering interest rates and making investment less expensive. Investment creates demand and hence GDP grows. e. Why did the gold standard make countries more prone to banking and financial crises in the early 1930s? What other factors made them vulnerable to banking crises? During a banking panic, the proper response for a central bank is to act as a lender of last resort (LOLR). LOLR means that as depositors as for liquidity, the central bank lend cash to local banks. The goal is to let depositors know their money is safe and that they need not panic. Lending money to banks requires increasing the money supply to cover such demand. However, the ratio of money to the gold stock should remain roughly constant in order to make the commitment to the gold standard credible. Moreover, the gold standard requires the money supply stay constant. Printing more money will lead to depletion of the gold (and/or foreign exchange) reserves which will lower the credibility of a currency and increase the likelihood of a “speculative” attack on the currency. The attack would quickly drain the country of gold and force the country off the gold standard. That is at odds with the objective of staying on the gold standard. Therefore countries cannot both save their banking system and maintain the gold standard. 7 END OF EXAM 8