International Monetary Economics
ECO 365 - International Monetary Economics
Prof. Jordi Mondria
Problem Set 1 Solution
SHORT-ANSWER QUESTIONS
1. Because, they argue, Americans are living beyond their means. They say a trade deficit and inflow of foreign capital can be healthy if the U.S. is investing in projects that generate future wealth. But in recent years, investment has been weak. Imported capital has primarily allowed U.S. consumers to go on a spending binge. In the third quarter, personal saving was just 0.4% of after-tax income, the lowest ratio since at least World War II. As for the rise in Americans’ wealth, some say it’s largely the result of a bubble in the housing market.
2. Globalization sets constraints on governments’ capacity to raise the revenues needed to manage exceptionally large debt-to-GDP ratios. As factors of production become more mobile, they become more difficult to tax. Companies can ever more readily move production to countries where tax rates are lower. As global investment options expand, taxing wealth-holders has become harder too. Even labour cannot be relied on to remain at home. Indeed, countries that fail to achieve offsetting efficiencies
(for example, by keeping after-tax rates of return competitive through above-average productivity growth) may find it increasingly difficult to borrow as the 21st century rolls on. Otherwise, if a government allows its debts to rise too far, there will be an exodus of capital and labour that strains the ability to repay of the investors and workers who remain. Exacerbating this will be the diminished ability of governments to borrow, even at home, without indexing debt to major currencies. Indexation also pushes down levels of sustainable debt, as it increases vulnerability to exchange-rate adjustments that might otherwise be desirable.
3. Simply put, if lenders are confident they will ultimately be bailed out by heavily subsidised
IMF loans, they will extend too much credit to emerging-market debtors at
Prof. Jordi Mondria
Problem Set 1 Solution
SHORT-ANSWER QUESTIONS
1. Because, they argue, Americans are living beyond their means. They say a trade deficit and inflow of foreign capital can be healthy if the U.S. is investing in projects that generate future wealth. But in recent years, investment has been weak. Imported capital has primarily allowed U.S. consumers to go on a spending binge. In the third quarter, personal saving was just 0.4% of after-tax income, the lowest ratio since at least World War II. As for the rise in Americans’ wealth, some say it’s largely the result of a bubble in the housing market.
2. Globalization sets constraints on governments’ capacity to raise the revenues needed to manage exceptionally large debt-to-GDP ratios. As factors of production become more mobile, they become more difficult to tax. Companies can ever more readily move production to countries where tax rates are lower. As global investment options expand, taxing wealth-holders has become harder too. Even labour cannot be relied on to remain at home. Indeed, countries that fail to achieve offsetting efficiencies
(for example, by keeping after-tax rates of return competitive through above-average productivity growth) may find it increasingly difficult to borrow as the 21st century rolls on. Otherwise, if a government allows its debts to rise too far, there will be an exodus of capital and labour that strains the ability to repay of the investors and workers who remain. Exacerbating this will be the diminished ability of governments to borrow, even at home, without indexing debt to major currencies. Indexation also pushes down levels of sustainable debt, as it increases vulnerability to exchange-rate adjustments that might otherwise be desirable.
3. Simply put, if lenders are confident they will ultimately be bailed out by heavily subsidised
IMF loans, they will extend too much credit to emerging-market debtors at