Question one (75 marks)
Read the adjusted text taken from an FT article on the Ghanaian currency and economy.
Ghana currency plunge recalls Argentina fears – Surprise rate cut blamed for this year’s worst forex sell-off,
Central bankers in Accra, Ghana’s tropical capital city, will have felt the heat rise over the past month […] However, matters are nowhere near as bad as in Argentina, at least not yet, in west Africa’s second-largest economy. However, Ghana’s currency, the cedi, has fallen 9.8 per cent to an all-time nominal low against the dollar since the central bank (the Bank of Ghana) surprised markets by cutting rates by 100bp to 16 per cent on January 28, making the cedi the worst performing currency this year of the 140 tracked by Bloomberg.
[…] To be fair to the Bank of Ghana, its decision to cut rates may have appeared sound. Inflation had fallen from 19 per cent to a six-year low of 9 per cent, within the bank’s target range of 8 per cent, plus or minus 2 percentage points, and was forecast to remain under control. And even with the rate cut, real rates were still a chunky 7 per cent, among the highest in frontier markets. The MPC said that “immediate risks to the disinflation path are well contained” and inflation expectations “well anchored”, and that it thus saw “scope to translate some of the gains in macro stability to the economy” by easing short-term rates.
[…] The bank’s decision reflected “a difficult trade-off between easing tight domestic financial conditions and preserving the attractiveness of local assets for foreign investors,” said Mr Smith. Unfortunately for Ghana, it is more vulnerable than most to sentiment in the world’s financial capitals. Foreign investors currently hold 30.6 per cent of Ghana’s local currency bonds, one of the highest rates of foreign ownership among emerging and frontier nations […]
[…] This coincided with seasonal demand for dollars from Ghanaian importers, which are now receiving invoices for goods imported in the run-up to Christmas. Although this happens every year, importers have accelerated their buying. “When they see the dollar getting ahead of itself and the cedi getting weaker, people bring forward their [dollar] purchases,” said Mr Asante, who was critical of the central bank for not anticipating the dollar shortage.
[…] Mr Asante was confident that the Bank of Ghana was belatedly getting into a position to supply the market with sufficient dollar liquidity. A $500m-$750m bridge financing arrangement with a consortium of banks should be concluded by the end of this month, he said, while the Ghana Cocoa Board, the state marketing organisation, should be able to draw down $300m against this year’s crop.
A) What kind of underlying exchange rate regime is implied in the article? Provide a short explanation and comparison of advantages and disadvantages of floating and fixed exchange rate regimes in your answer. [15 marks]
Below are two questions asking about different influences on the exchange rate of the Ghanaian Cedi versus the US$ that are discussed in the article above. In each question, assume ceteris paribus and do not consider the discussion and changes from the other questions.
B) Consider the scenario described in the article and focus on one changing factor at the time (ceteris paribus), explain how monetary policy intervention influenced the exchange rate of the Cedi versus the US$. Use a diagram in your answer. [30 Marks]
C) Consider the scenario described in the article and focus on one changing factor at the time (ceteris paribus), explain how an increased demand by foreign investors for Ghanaian government bonds will influence the exchange rate of the Cedi versus the US$. Use a diagram in your answer. [30 Marks]
The exam will only contain two scenarios, but here is a third alternative one here for you to practice:
D) Consider the scenario described in the article and focus on one changing factor at the time (ceteris paribus), explain how the seasonal changes in demand for imports into Ghana will influence the exchange rate of the cedi versus the US$. Use a diagram in your answer. [30 Marks]
Question two (125 marks)
Read the following text adapted from an FT article on the French fiscal policy to address the recession caused by the Coronavirus pandemic.
France launches €100bn coronavirus recovery plan – Almost a third of funds will go towards green investments, including hydrogen energy, Victor Mallet in Paris SEPTEMBER 3 2020
France has launched a €100bn plan to rescue its economy from the coronavirus crisis with big investments in green energy and transport as well as industrial innovation. Announcing the “France Relance” (France Relaunch) plan in Paris on Thursday, Prime Minister Jean Castex said its “historic ambition and size” made it almost four times as large as the national plan introduced after the 2008 financial crisis. At 4 per cent of gross domestic product, it was the “most massive” plan unveiled in Europe so far relative to the size of the economy, he said. Ministers said €30bn of the plan would be spent on “ecological transition”, including €9bn on the development of a hydrogen industry and other green technologies, €4.7bn for the state railways and €6.7bn on improving insulation in homes and public buildings. The European Commission and the German government are also promoting hydrogen technology. A further €35bn will go to industrial competitiveness and innovation, including €20bn in reduced production taxes for industry over two years and €1bn to help the “reshoring” of strategic businesses in sectors such as health and IT. The final €35bn is for “social and regional cohesion”, including employment projects and skills training for the young. Unlike Germany’s €130bn recovery plan, which included a cut in value added tax, France’s strategy aims primarily to boost investment rather than stimulate demand. The government expects the economy to shrink up to 11 per cent this year as a result of the pandemic and a nationwide lockdown from mid-March to mid-May, and the state has already spent tens of billions of euros to avert mass bankruptcies and a surge in unemployment. […] Mr Castex and Bruno Le Maire, the finance minister, both said they expected the economy to recover to its pre-crisis level by 2022 as a result of the huge investments contained in the plan, of which €40bn will come from EU grants disbursed by the bloc’s €750bn recovery programme brokered in July by French president Emmanuel Macron and German chancellor Angela Merkel. […]
One unintended consequence of the crisis has been to increase the role of the state in the economy — Mr Le Maire called it a “rebalancing of the roles of the market and the state” — and some economists warned that there was a risk of the government assuming it could pick “industries of the future”. “The risk of misallocation is high,” said Augustin Landier, finance professor at HEC Paris, complaining of a “fuzziness” in the new plan. Jean-Hervé Lorenzi, president of the Cercle des Economistes, said the plan needed to be accompanied by confidence-building measures to persuade French consumers to release the €100bn of precautionary savings they had made this year, as well as by more measures to encourage housing construction and support new entrants to the job market. But he added: “On the whole, no one is going to attack this plan head on. It’s up to the job, and it’s the size it needs to be.”
A) Briefly discuss the specific characteristics and evaluate the potential positive and negative effects of the fiscal policies adopted by the French Government to tackle the recession induced by the Coronavirus pandemic in 20200 and explain and illustrate the theoretical impact of these fiscal policies using the Keynesian Cross diagram. Explain the multiplier effect and show it in your diagram. [30 marks]
B) Explain how the accelerator effect and time lag arguments apply to the French fiscal policy measures. [20 marks]
C) A major pandemic forces the government to lockdown the population and reduce production in large sections of the economy for several months. Explain how this might impact the economy. Show (draw) the impact of this scenario using the Classical 4×4 diagrams and the Classical aggregate supply and demand diagram. Explain the changes (shifting elements) as well as causes and effects in the diagrams. [45 marks]
D) Explain how one of the alternative indicators (HDI, GNHI, Ecological Footprint and Time Use Indicator) measures welfare. Drawing on the alternative welfare indicator you have explained, evaluate the usefulness of GDP as an appropriate measure of welfare for a country. Make sure to respond to the following questions:
- Based on what kind of welfare criteria and theoretical concepts is the alternative indicator constructed?
- How is the indicator measured empirically?
- What is the critical observation of GDP’s inadequacy or limit as a welfare indicator the alternative indicator does try to address?
[30 marks]
