Assignment 3

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Assignment 3

Question 1

a

The exchange rate pass-through is incomplete due to the domestic currency expressed on the imported goods. The effect from depreciation on the import prices reflection enables it top be full or incomplete (Bailliu and Bouakez 22). Magnitudes of exchange rate pass-through for Canada border on the zero mark of the consumer price index, while in the USA, it borders the five-point mark over similar period.

b

In recent years, the degree of pass-through has declined due to the market segmentation increase. More companies have increased their PTM engagement behaviors while larger proportions of goods are increasingly subjected to discrimination of prices on the international markets (Bailliu and Bouakez 22). In addition, the state of economy has affected the endogenous processes thereby reducing the pass-through.

Question 2

a

Shadow banking is a terminology that refers to intermediaries that perform similar functions to commercial banks on the traditional aspects of services and finances (International Monetary Fund 1). The contributing factors to the growth of shadow banking include search for yield within a market zone, circumvention of regulations that permit its operations and demands driven by the institutional investors.

b

The advantages of shadow banking is that the institutions do not need to have the large financial reserves as the commercial banks, there is increased borrowing that can be translated into investments, and it can be vital in survival of dwindling firms in tough economic times. Te demerits of shadow banking is that the high leverage devoid of regulations increases risks of higher losses, the sale of assets through the systems are more difficult and increased risk associated with them.

Question 3

Using the AA-DD model curves, massive quantitative easing within the Euro zone provides the synthesis of foreign exchange market of the Euro against other currencies together with the output level in the same circumstance. Given E as the price of the US$ in respect to Euro, the asset market from the latter will stabilize since the yields will be deleveraged on a lower basis (Suranovic 1). It will be shielded from the lag created between inflation and monetary growth. The Euro unit currency will ease when the output levels are heightened on the monthly levels. The demand will shift due to the bank’s transfer payments and foreign prices dependent on E and output levels are arrived at equilibrium. The Euro will emerge stronger than E per unit level of the output as higher market evaluation is obtained from purchased bonds.

Question 4

a

According to the diagram of the AA-DD curves, the fall in demand of oil for Canada and Saudi Arabia is represented by the shifting equilibriums attained from the first one to the third one, depending on the supply and demand from A and D.

b

The Central Bank of Saudi Arabia will have to restore the original exchange rate of 3.75 Riyal for equivalent one USD by lowering the supply as shown by intersection of A and D in respect to supply of the oil dependent on demand from Canada, the massive quantity easing can facilitate the upheaval on output levels. Thus, the shift will be realized as the necessity increases and equilibrium gained will be on the differential gaps between G and F.

c

The floating exchange in Canada provides for an advantage to the host country due to better economic growth and placing over Saudi Arabia. It offers advantage on the lowered exchange rats and increase of demand at the expense of the Riyal die to output level and bargaining power.

Question 5

One of the key advantages of the GDP-linked bonds is reduction of the probability of default payment in terms f the debt service. The security offered enables countercyclical features especially to the narrower range offered as compared to fixed bonds. The GDP-linked bonds also offer automatic stabilization while limiting the spending in high growth periods. They offer a balanced improvement in welfare through balanced debt repayments especially when they are in the lower periods (Forstater 14). One of the main disadvantages of GDP-linked bonds is the political economy associated with a country and its effect towards the issuer. In the good times, more amounts have to be paid to the debt holders. Secondly, the bonds misreport growth while not revising on the GDP as a means of repressing the growth. In addition, GDP-linked bonds do not offer sufficient amounts of security investments on the fewer incentives. There is an added discrepancy in equity-like instruments, which have no legal claims on principal.     

Works Cited:

Bailliu, Jeannine, and Hafedh Bouakez. “Exchange rate Pass-through in Industrialized Countries.” Bank of Canada Review, 1 (2004): 19-28. Print.

 Forstater, Mathew. Economics. Chicago: Chicago Review Press, 2007. Print.

International Monetary Fund. Global Financial Stability Report. IMF, Web. 26 March 2015. < http://www.imf.org/external/pubs/ft/gfsr/index.htm >

 Suranovic, Steve. International Finance: Theory and Policy. FlatWorldKnowldege, Web. 26 March 2015. < http://catalog.flatworldknowledge.com/bookhub/26?e=suranfin-ch09_s01 >