Reference no: EM132471695

1. In South Korea over the past several years, the real GDP, Y, of has been growing by 3 percent per year and the price level, P, also by 3 percent (that is, DP/P = 0.03 and DY/Y = 0.03). The nominal interest rate, i, has remained constant, the money market has been in equilibrium, and money demand can be represented by M^d = kPY/i, where k is a constant parameter. The money market equilibrium implies M^s= kPY/i, where M^s is the money supply. For the purposes of this question, please use the growth form of the equation for the money market equilibrium, DM^s/M^s @ DP/P + DY/Y - Di/i, which is a close approximation of the original because the growth rates are small numbers.

(a) At what rate has the South Korean money supply been growing (i.e., what is DM^s/M^s)? Please show your calculations.

(b) Suppose this year South Korea's real GDP growth jumps to 4 percent. If rates of growth of the price level and money supply remain the same as in the recent past, what will happen to the nominal interest rate in Korea? Please find the growth rate of the interest rate, and show your calculations.

(c) In question 1(b) when GDP grows at the rate of 4 percent and the price level grows at the rate of 3 percent, if the central bank of South Korea wants to keep the nominal interest rate constant as in the past, at what rate should it increase the money supply? Please show your calculations.

2. This question is based on the article, "Yield-curve control could prove a useful tool in the next recession," published by The Economist on February 1, 2020. The article discusses the effectiveness of conventional and unconventional monetary policies and asks whether additional policy tools may be needed for dealing with the next recession. Conventional monetary policies consist of open market operations and the discount rate and minimum reserve requirement adjustments, all of which are aimed at guiding short-term interest rates to desirable ranges. The unconventional monetary policies are other tools that central banks may use. The article mentions three unconventional monetary policies, namely, negative interest rates, quantitative easing (QE), and yield curve control.

(a) According to the article, what are the reasons why central banks have turned to unconventional monetary policies in the past two decades? [7] What countries have experienced the limitations of conventional monetary policy tools in the past two decades, and what events have prompted the wider use of unconventional tools?

(b) According to the article, have negative interest rate policy been implemented anywhere? [2] What are the disadvantages of negative interest rates as an unconventional monetary policy tool?

(c) According to the article, how does quantitative easing work? What is the difference between QE and open market operations? What are the limitations of QE?

(d) According to the article, how does yield curve control work? What are the similarities and differences of yield curve control with the open market operations?

3. Extra Points Question: Suppose Indonesian banks have borrowed heavily in foreign markets and have lent to domestic construction companies. If the Indonesian rupiah devalues strongly, the banks will not be able to pay back their foreign debts. Global investment bankers become concerned about that possibility and stop lending to Indonesia. To assure the creditors, Indonesia's central bank issues a statement indicating that it would provide cash rupiahs to the banks in trouble in case of a large devaluation to prevent them from failing. Should the global investment bankers be reassured by this statement or not? Why? Please explain your answer.