Assignment 1: Macro Forecasting

Due Wednesday, February 4 at the start of class. Assignments will not be accepted late without prior arrangement. The assignment consists of two parts. The first one, described below, should be done and submitted as a group; submit your forecasts with the names of all group members.  The second part should be done individually and consists of your individual forecasts to be submitted electronically in the course homepage section entitled  A MACRO FORECASTING GAME; the deadline for this part of the assignment is Tuesday February 3.  The individual forecast may differ from those you presented as a group; the student with the best forecasting record will receive a prize during the last lecture of the course (May 4). We will spend part of the February 4 class discussing what the Fed will decide about interest rates during the FOMC meeting taking place that day. So be prepared for a class discussion.

This assignment is designed to give you a clear objective as you read articles on current developments in the business press and a feel for the uncertainty surrounding current and future economic conditions.

Provide forecasts for each of the following variables with a detailed explanation following each number which explains how and why you chose the number. At the end, summarize how your forecast on growth and inflation relates to your forecast on Fed policy, long-term interest rates, the stock market and the US $ exchange rates.

1. Real chained GDP growth for 1998 Quarter I - SAAR (Seasonally Adjusted Annual Rate).

2. Growth rate in the deflator for GDP (GDP Price Index with Chain Weights) for 1998 Quarter I - SAAR.

The advance data for 1997 Quarter IV will be announced at the end of January and the advance estimate for 1997 Quarter I should be announced at the end of April. The actual final data for the 1997 Quarter III were 3.1% for GDP growth and 1.4% for the growth rate in the GDP deflator (Chain-Weight Price Index).

3. a) Will the Fed change the Federal Funds rate at the FOMC meeting on February 4 and by how much ? b) Will the Fed change the Federal Funds rate at the FOMC meeting on March 31 and by how much ? c) What will be the Fed Funds rate reported on page C1 of the Wall Street Journal on May 1, 1998 ?

4. The 30-year Treasury bond rate reported on page D1 of the New York Times on May 1, 1998.

5. The Dow Jones Industrial Average index of the stock market reported on page C1 of the Wall Street Journal on May 1, 1998.

6. The exchange rate for the Japanese Yen (Yen per US Dollar) and the Deutsche Mark (DM per US Dollar) reported on page C1 of the Wall Street Journal on May 1, 1998.

7. The exchange rate for the Korean Won (Won per US Dollar) reported in section C of the Wall Street Journal on May 1, 1998.

While searching for background information for your forecasts you might find useful to look into the large amount of economic information and data available on the Internet. The starting place is the course homepage on Business Cycle Indicators.  See also references to WEB data, analysis and information in the course home pages on Macro Data and Macro Readings and Analysis. One excellent WEB resource is "Economic Trends" by the Research Department at Federal Reserve Bank of Cleveland. This is a monthly source for analysis and charts of US business cycle conditions. Latest economic statistics are charted and the current state of the economy is discussed in detail. Topics analyzed include: The Economy in Perspective, Monetary Policy, Inflation and Prices, Economic Activity, Labor Markets, Banking Conditions, International Trade, Global Savings and Investment. See also the course home pages on the Business cycles perspectives for 1998 and Will the Fed tighten or loosen monetary policy at the next FOMC meeting?

Assignment 2: Economic and Financial Indicators

Due Monday, February 23 at the start of class. Assignments will not be accepted late without prior arrangement.

1. CPI Debates
As the debate on the Commerce Department decision to switch from a "fixed-weight" to a "chain-weight" measure of real GDP and the controversy on the results of the Boskin Commission show, one of the difficulties of measuring aggregate movements in prices and output is that prices of goods change at different rates. To see how this affects our interpretation of the data consider a stylized version of the US economy producing consumer goods and capital goods (think: computers), as summarized by the following numbers (quantities are trillions):

                       1994  1995

Consumer goods
     Price              1    1.05
     Quantity           5    5.01

Capital goods
     Price              1    0.90
     Quantity           1    1.20
(a) Compute the total value of goods produced, or GDP, for both years in current prices and in 1994 prices.

(b) Use your answer to (a) to compute the implicit price deflator, the inflation rate from 1994 to 1995, and the growth rate of GDP.

(c) Suppose you feel that the decline in the price of capital goods is understated - that with proper adjustment for quality improvement the price fell by 25 percent, not the 10 percent reported above. What effect does this have on your estimates of (i) inflation and (ii) real output growth ? (A qualitative answer is sufficient).

(d) How does the answer to (c) affect your opinion of the relative merits of a "fixed-weight" and a "chain-weight" method of measuring real GDP ? More generally, what are the other advantages and disadvantages of the two methods ?

(e) Recently, the Boskin Commission argued that CPI inflation is overestimated. Others have also argued that the both the switch to a "chain-weight" method of measuring GDP and this CPI mismeasurement affect our estimates of real GDP, productivity and their growth rates. Discuss the arguments in favor and against the recommendation of the Boskin Commission and the arguments on whether output and productivity are mismeasured and express your views on these issues. In writing your answers read the home pages and readings on the controversies on Inflation and GDP Measurement and Productivity Growth in the 1990s.

2. The Yield Curve
In January of 1995, prices of zero-coupon bonds of various maturities were:

         Maturity  Price

         1 Year    93.26

         2 Years   86.36

         3 Years   79.87

         4 Years   73.97
(a) Compute the yield for each of these instruments, and graph the resulting yield curve. [Comment: Use the method outlined in the Roubini and Backus Lectures, not the US Treasury convention used in the Wall Street Journal and elsewhere (which introduces semi-annual compounding, accrued interest, and other complications that I'd like to ignore)].

(b) Compute the forward rates associated with these bonds and plot them on the same graph as the yield curve.

(c) Approximate the risk premium on each forward rate by the difference between the average forward rate and the average yield on a one-year bond (see Table 1 of Chapter 2 of the lecture notes). For example, one estimate of the risk premium on the first forward rate is 0.909 = 9.472 - 8.563.

(d) Use your estimate of the risk premium and the forward rate curve to get an estimate of the market forecast of future short rates. Comment on (i) the predicted trend in short-term interest rates and (ii) the likely behavior of output growth and inflation in 1995 suggested by these data.

(e) Did the actual behavior of short-term interest rates, output growth and inflation in 1995 confirm what was suggested by the January 1995 yield curve ?

(f) Based on your reading of the U.S. yield curve today (early February 1998), what can you say about the market expectations about the movements of short-term (1-month and 3-month) interest rates in the next 6 months?

3. To defend or not defend?: Exchange Rate Dilemmas in Asia
Consider the uncovered interest parity condition modified for the case of a country risk premium (in the case when investors are risk-averse):

it  = itf + (E(St+1) - St)/St + RPt

where i is the domestic interest rate (the interest rate in emerging market country Emergia), if is the foreign interest rate (the US interest rate), st is the current spot exchange rate (Emergos per US Dollars) and  Et(st+1) is the expectation at time t of the value of the exchange rate a period ahead (say one year). Solving  the expression above for the current spot rate, we can rewrite the expression as:

St = [E(St+1)] / [ it  - itf + 1 - RPt]

(a) Suppose that initially:  st = Et(st+1) = 1 so that both the spot and expected future exchange rate are equal to 1; domestic and foreign interest rates are equal to 5% so that  i = 0.05 and if = 0.05; and there is no risk premium on domestic assets so that RP=0. Would the spot exchange rate change over time if nothing else changes? What would be the value of  the forward exchange rate at time t?

(b) Starting from the initial equilibrium, suppose that at time t investors change their expectation of the future exchange rate and now believe that the currency will be depreciated by 10% a year from now so that: Et(st+1) = 1.10. Suppose that the country is in a regime of flexible exchange rates. By how much will  the current spot exchange rate (st) change following this change in expectations? Explain also why.
Also,  how will the forward exchange rate change following the change in the expectation about the future exchange rate? (to answer this last part of the question use the covered interest parity condition).

(c) Now suppose that the country is committed to maintain the spot exchange rate fixed to the initial parity (st  = 1). Following the change in expectation about the future exchange rate (described above in point (b)), by how much should the domestic interest rate be changed by the domestic central bank in order to prevent a devaluation of the domestic currency, i.e. maintain the fixed parity? Explain why.
Also, how will the forward exchange rate change following the change in the expectation about the future exchange rate and the interest rate reaction of the central bank? (to answer this last part of the question use the covered interest parity condition).

(d) Now suppose that you start again from the initial equilibrium (described in (a) above). Suppose that investors change their view of the riskiness of the domestic asset. They now start to believe that the domestic asset is more risky than the foreign asset, maybe because of a risk of default of domestic assets. Specifically suppose that the risk premium on domestic assets goes from zero to 7% so that now  RPt = 0.07. Suppose that the country is in a regime of flexible exchange rates. By how much will  the current spot exchange rate (st) change following this change in expectations? Explain why.

(e) Now suppose that the country is committed to maintain the spot exchange rate fixed to the initial parity (st  = 1). Following the change in the risk premium (described above in point (d)), by how much should the domestic interest rate be changed by the domestic central bank in order to prevent a devaluation of the domestic currency? Explain why.

(f) Explain why the central bank may or may not be willing to change the interest rate following the exogenous changes in expected future exchange rate and/or risk premium described in points (b) and (d) above. First, suppose that the central bank does not change interest rates and lets the spot exchange rate be flexible and react to the shock to expectations (or risk premium);  what would be the effect of the movement of the exchange rate on the level of economic activity (aggregate demand, trade balance, output and unemployment rate) and inflation rate of the country?  Suppose alternatively that the central bank defends the fixed parity by changing interest rate: what would the the consequences of this change in interest rates on the level of economic activity (aggregate demand, trade balance, output and unemployment rate) and inflation rate of the country?  Which tradeoff is the central bank facing in deciding whether to let the currency float or defend instead the fixed parity?  How is this central bank dilemma (tradeoff) affected if the country has a very large stock of foreign currency denominated external liabilities (i.e. a large foreign debt in US $)?  Why will the effect on output of letting the exchange float be very different in the presence of a large stock of foreign debt?

(g) Finally, consider the current yield curve in a East Asian country (in January 1998). Find the data and draw the yield curve for a country of your choice (look in Bloomberg). Explain the reasons for the shape of the yield curve and what the slope of the curve says about future levels of economic activity in the country.

4. Current Account and Foreign Debt Accumulation in Asia

Chapter 3 of the lectures notes presented a detailed example of balance of payments accounts for Korea in 1996. Use the attached page for Thailand from the International Financial Statistics of the International Monetary Fund to compute the balance of payments accounts for Thailand for 1996. Use the exact scheme found in Chapter 3 for Korea to do the same exercize for Thailand (for comparison I also attach the equivalent page for Korea).
    Two caveats should be kept in mind while doing this exercise. First, the Errors and Omissions item should be included among capital inflows if it is positive or among the capital outflows if it is negative. Second, usually assets items in the capital/financial account have a negative sign since they represent an increase in foreign assets (a capital outflow that, by BP accounting practice, takes a negative sign). However, if a particular Asset item has a positive sign, this means that the country reduced its stock of foreign assets of that type during the year. In this case, the item should be put in the capital inflows section of the accounts with a positive sign rather than in the capital outflows section. In fact, a reduction in the gross stock of foreign assets is equivalent to the repatriation of previous capital outflows, i.e. it is formally a capital inflow.

Assignment 3: Productivity Debates, NAIRU, Supply Side Economics and Income Inequality

Due Monday, March 9 at the start of class. Assignments will not be accepted late without prior arrangement.  Some of the topics in this assignment will be part of a class discussion on March 25 for the 10.00am Section (March 30 for the 8.30am Section) with the participation of Professor Robert Solow, Nobel Prize winner.

1. Not only do countries grow at much different rates, they often grow for different reasons. Consider three countries that have been popular recently with emerging-market investors: Brazil, Mexico and Singapore. Some relevant statistics (which you should take with a grain or two of salt) include:

       Growth Rate  Brazil  Mexico  Singapore

       Output        3.6     4.9       8.4
       Population    2.4     2.7       6.4
       Capital       3.0     3.2      11.3
Growth rates are annual percentages for the period 1960 to 1990.

(a) Use the data to decompose output growth in each country into components due to capital, labor (which we are approximating with the population), and productivity growth.

(b) Use your numbers, and any other factors you think are relevant, to comment on the growth experience of these three countries. In particular, comment on the Krugman controversial view that the Asian economic "miracle" was not due to total factor productivity (TFP) growth but rather to intensive use of inputs. In this regard read the articles in The Economist "The miracle of the sausage makers" and "The Asian Miracle: is it over?"  (both are available in the Reading Package). Do you agree or not with Krugman's view, and why ?

The rest of this assignment requires a critical reading of some of the macroeconomic policy controversies in the reading list. For each question read first the home page on the relevant controversy and most of the other readings in the links to the controversy under consideration. Then, answer the questions.

2. A debate has been raging in 1996-97 on whether productivity growth has been increasing in the 1990s relative to its dismal performance in the 1970s and 1980s and whether we are now in a New Economy where sustained high growth without inflation is possible. The debate started with the contentious switch to a "chain-weight" method of measuring GDP and productivity and has developed into a debate on the role of computers and service sectors in productivity, on whether productivity is underestimated, whether sustained productivity growth is possible in the US economy today and whether we are now in a "New Economy" where a "New Paradigm" of high growth and low inflation holds.  An aspect of this debate is the question of whether we have already reached the NAIRU. Some (such as Krugman, Blinder and Roach) argue that NAIRU is about at 5-5.5% unemployment rate (or 2.5% growth); since growth has been recently well above 2.5% and the unemployment rate below 5% these authors argue that there are serious risks of increasing inflation if the economy grows at the current rates and if the unemployment rate falls further. Others argue that NAIRU is today close or below the current unemployment rate of 4.7%, i.e. that natural long-run growth rate of GDP is higher than 3.0% and closer to 3.5-4.0%. Such arguments come (for different reasons) from the right (supply siders and The Wall Street Journal editorial page) and the left (Eisner and Thurow). Others authors (Angell, Mankiw, Rosett) take a middle view.
Discuss the evidence in favor and against the alternative views presented in these debates on NAIRU, the New Economy and productivity growth and present your opinions on these issues. In writing your answers read the home pages and readings on the controversies on  NAIRU , Inflation and Output Measurement and Productivity Growth in the 1990s and The New Economy: Myth or Reality?.

3. Following a recent speech on January 3 by Fed Chairman Alan Greenspan and recent inflation trends in the U.S. and abroad, the issue of "deflation" (i.e. negative inflation) has entered the policy debate. Some argue that we are on the verge of global deflation while others do not believe that we should disregard the risks of new inflationary pressures in a high growth economy. Discuss the evidence in favor and against the alternative views presented in this debate on deflation and present your opinions on this issue. In writing your answer read the readings in the homepage on Deflation.

4. Since Steve Forbes argued in 1996 in favor of replacing the current income tax system with a "flat tax" and Bob Dole presented in the summer of 1996 a tax plan based on reductions in income tax rates and cuts in capital gains taxes, the debate on "supply side" economics has started to rage again. Congress passed in 1997 a budget package including a reduction in the capital gains tax and Republicans are likely to present in 1998 alternative proposals for a radical reform of the U.S. tax system (in the direction of either a flat income tax or a consumption tax).  At the core of this debate there are various questions that require an empirical answers. Do lower tax rates significantly increase labor supply, savings and investment? Do lower tax rates lead to higher income levels and/or higher growth rates of the economy? Do lower (higher) tax rates increase or reduce the budget deficit? Discuss the empirical evidence on these questions based on the US experience in the 1980s (the 1982 Reagan tax cuts and the 1986 tax reform) and the 1990s (the 1990 Bush tax increase and the 1993 Clinton deficit reduction package) and present your views on this subject. In writing your answers read the relevant articles in the reading package and the readings in the homepages on the controversies on Supply Side Economics and Capital Gains Taxes.

5. Has income and wealth inequality increased in the last two decades in the United States? What is the degree of class (income mobility) and has it changed over time? What are the possible explanations of the alleged worsening in inequality? Should we care as policy makers about such increase in inequality or not? Discuss first the empirical evidence on these questions and present your views on this subject. In writing your answers read the home pages and readings on the controversies on Income Inequality, Supply Side Economics and Capital Gains Taxes.

Assignment 4: Argentina's Inflation and Stabilization Experience

Due Wednesday, April 8.  Part of the   class will be devoted to a discussion of the case.

There are two sets of questions in this assignment. The first set need to be answered in writing and turned in prior to the class discussion of the case. The second set of questions should be thought through by each group. You should be prepared to discuss these in class.

A. Questions to be handed in.

Read of the case studies " Reducing Inflation in Argentina: Mission Impossible ?" by Fernando Alvarez and Stephen Zeldes and "Lessons from the Stabilization Process in Argentina: 1990-1996" by Domingo Cavallo and Sonia Cavallo. Then, answer the following questions. In answering some questions, you need to use an EXCEL spreadsheet with data that is available for download. Click here to download this spreadsheet.

1. Write down an equation that describes the relationship between inflation, the growth rate of the nominal money supply, and any other relevant variables. What does it say about the causes of inflation ?

2. Calculate the annualized percentage change of the CPI, the monetary base and the money supply (as given by M1) for the following one year periods:

i. 1978.01 - 1979.01

ii. 1980.01 - 1981.01

iii. 1982.01 - 1983.01

iv. 1984.01 - 1985.01

v. 1986.01 - 1987.01

vi. 1988.01 - 1989.01

vii. 1990.01 - 1991.01

3. Based on the relationships revealed in your calculations for the previous question, is there a positive, negative, or zero empirical relationship between inflation and the growth rate of the monetary base, and between inflation and the growth rate of M1 ? Are there relationships perfect ones ? Relate this to your answer in 1).

4. Whenever a central bank prints "fresh money" it can obtain goods and services in exchange for these new pieces of paper. The amount of goods and services that the government obtains by printing money in a given period is called "seignorage". In real terms, this quantity of goods and service is given by the following expression:

Seignorage = New bills printed during the period / Price level during the period.

The monetary aggregate that the central banks control directly is the "monetary base", consisting of currency in the hands of the public and reserves of the commercial banks deposited in the central bank. Thus, when we refer to a central bank as "printing more money", we mean increasing the monetary base.

Using the formula below, compute the annual seignorage obtained in the previous 12 months, for each month starting in January of 1978.

Seignorage = [Baset - Baset-12 ] / [(Pt + Pt-1 + ... + Pt-11 ) /12 ],


[Baset - Baset-12] = the change in the monetary base between a given month and 12 months earlier (t and t-12), and

[(Pt + Pt + ... + Pt-11 ) /12 ] = the average price level over the last 12 months.

5. Since this amount of seignorage is a source of government revenue, how can you explain the fluctuations of seignorage over time. Try to relate this to the budget deficits in Argentina.

6. Describe exactly what type of policy (in terms of selling and buying dollars against pesos), the central bank has to engage in order to fix (control) the exchange rate against the dollar. Assume that the central bank will not interfere with capital movements, that is it will not tax or control foreign inflows or outflows of financial capital.

7. The data set included in this case has information about nominal interest rates in pesos in Argentina, and nominal interest rates in dollars in the US, for different months at the start of the Convertibility Plan. For Argentina, we present two interest rates, an interest rate on deposits at commercial banks of approximately 1 month maturity and an interest rate on CDs in the US. Consider the returns from two investment strategies for a US dollar investor:

(A) Invest the dollars in a US asset.

(B) Exchange the dollars into pesos, deposit these in a peso-denominated account with the same maturity as in (A), and, at maturity, convert the pesos back to dollars, assuming that the exchange rate is the same at the beginning of the operation (when dollars were converted into pesos) as at the end (when pesos were converted back into dollars).

a) Compute the difference between the returns form strategies (A) and (B) for each month from January 1991 until the end of 1992, using both deposit rates in the US and Argentina. Which strategy would have yielded a higher ex-post return ?

b) Calculate for each month, what percentage changes in the exchange rate would have made the returns on (A) and (B) identical. What is the difference between these changes and the actual changes that took place in the exchange rate ? If the uncovered interest parity condition holds, how do you explain such a difference ? What about the possibility of a risk premium on peso assets ?

8. Compute the annualized growth rates of the exchange rate (depreciation rate) and of the CPI index (inflation rate) for the following one year periods:

i. 1976.01 - 1977.01

ii. 1978.01 - 1979.01

iii. 1980.01 - 1981.01

iv. 1982.01 - 1983.01

v. 1984.01 - 1985.01

vi. 1986.01 - 1987.01

vii. 1988.01 - 1989.01

viii. 1990.01 - 1991.01

Is there a positive, zero, or negative relationship between inflation and the rate of depreciation of the currency ?

B. Questions for class discussion (not to be handed in).

The key question is the following:

Was the Cavallo plan likely to succeed at reducing inflation and why ?

In addition to this key question, the following questions will form the basis for the main discussion in class.

1. How high was the average inflation in Argentina in the 1980s ?

2. What were the costs to the citizens of Argentina of this high rate of inflation ? Are there different costs to steady, predictable inflation as opposed to unpredictable, highly variable inflation ? Who benefits and who loses as a result of surprise inflation ? Are the costs per percentage point of inflation higher at very high rates of inflation or at low rates of inflation ? Is there likely to be any impact of very high inflation on labor productivity ?

3. Why did Argentina have such high inflation in the 1980s ? Do these same factors tend to be at work in other countries that have very high rates of inflation ?

4. Can government policies contribute to high inflation ? If so, which ones ? Why might a government pursue policies that they know will result in inflation ?

5. Are there any limits to the revenue that the government can collect through seignorage ? For example, could the government "buy" the entire annual GDP by printing money ?

6. How can the government use creative accounting to mispresent its fiscal accounts ?

7. What were the similarities and differences between the 1991 Cavallo plan and previous stabilization plans, such as the 1985/86 Austral plan, the July 1989 Menem plan and the December 1989 Gonzales plan ? Which elements of each plan were attractive or unattractive ?

8. Many argue that in a low inflation economy there is a short run tradeoff (the Phillips curve) between inflation and unemployment, so that reducing inflation is likely to lead to a short-run drop in real GDP and a rise in unemployment. Are these effects likely to be present in Argentina ? What are the factors in the Argentinean situation that would make these effects on unemployment and output higher or lower than they would be for reducing a moderate amount of inflation (such as in the U.S.)?

9. As the Argentine Central Bank followed the convertibility plan, it was transformed to a "currency board". Describe the assets and liabilities of a currency board. Can a currency board generate profits or losses ? Would having a currency board alter the amount of seignorage that the government could collect ?

10. What did the formation of a currency board mean for Argentine exchange rate policy ? What would happen if absolutely everybody that holds pesos would like to exchange them for dollars ? Could a run or speculative attack start against the currency ? How should the currency board respond to a speculative attack ?

11. What are the benefits and costs to society of using a currency board as a part of the stabilization plan ?

12. What information about the confidence of the private sector in the central bank commitment to a fixed exchange rate can be assessed from the differential between Argentinean and U.S. interest rates (assume that bonds have similar default risk and maturity but that they differ only in that one is denominated in dollars and the other is denominated in pesos) ?

13. What have been the consequences of the Cavallo plan for the economic performance of Argentina in the 1990s ? How do you explain the large increase in the unemployment rate in the 1990s and the recession in 1995? Could the 1995 recession and increase in the unemployment rate have been avoided with a different exchange rate policy?

Assignment 5: The Mexican Peso Crisis of 1994-95

Due Wednesday, April 22 at the start of class. Be prepared to discuss the case in class.

There has been a wide debate on the causes of the Mexican Peso crisis of 1994-95. There are at least three competing (but not necessarily incompatible) views of the causes of the crisis:

1. The "Unsustainable External Position" View.

According to this view an stabilization program under a regime of fixed exchange rate and capital mobility leads a real exchange rate appreciation and a worsening of the current account that becomes eventually unsustainable. The real appreciation is caused by a number of factors: first, domestic price and wage inflation is sluggish (subject to inertia) so that inflation falls slower than the controlled rate of depreciation of the currency (or fixed exchange rate if the crawl rate is close to zero). Second, an exchange rate based stabilization leads to a fall in the real interest rate (as nominal interest rates fall faster than inflation once the currency is pegged); this is turn leads to an expansion in aggregate demand that cause protracted current account deficits and a real exchange rate appreciation. Even though they are driven by private sector behavior (a fall in private savings), rather than an inadequate fiscal position, the current account deficit and the real appreciation can eventually become unsustainable. Therefore, at some point a big real exchange rate depreciation is needed to restore the initial level of competitiveness and current account equilibrium.

2. The "Adverse Shock" View.

According to this view Mexico was subject to a large number of exogenous domestic political and external economic shocks during 1994. It has been argued that it was very difficult for the Mexican authorities to gauge the size or anticipate the recurrent nature of these shocks. The Mexican authorities reaction to the March events appeared to have restored a relative calm in the foreign exchange and financial market until November. Therefore, it may well have appeared reasonable to continue with the 1994 policy of sterilizing the monetary impact of international reserve losses to offset the effects of what were perceived to be temporary political and external shocks.

3. The "Policy Slippages" View.

According to this view the large number of adverse shocks that hit Mexico in 1994, added to the potential vulnerability stemming from weakness in the external accounts, called for a much tighter monetary policy than the one followed, and probably also for an early widening of the exchange rate intervention band, so as to assure the markets that the authorities were fully committed to sustaining the exchange rate regime. The failure to tighten monetary policy and raise interest rate enough during 1994 seriously hurt the credibility of the authorities' commitment to defend the exchange rate.

First, discuss in detail the specific evidence in favor and against each of these three views; in each case, provide data and reasoning supporting or criticizing the alternative views. The "Factors Behind the Financial Crisis in Mexico," and "Evolution of the Mexican Peso Crisis," in your case package are a good source of background information, but you may want to add to it. A very good Internet resource is the World Bank's Home Page on the Mexican Peso Crisis. (URL:

Second, compare the experience of Mexico in 1994-95 with that of Argentina in 1995. Was Argentina able to avoid the sharp depreciation experienced by Mexico?  Which policies did Argentina pursue to prevent a depreciation of its currency? Were there any real costs (in terms of  output and unemployment) of the Argentinean policies aimed at defending its currency board? Why or why not? The background  data and information on Argentina in the 1990s is provided in the paper by Cavallo and Cavallo "Lessons from the Stabilization Process in Argentina: 1990-1996" that is included in the case package for Assignment # 4 (Argentina).

Assignment 6: The Asian Economic and Currency Crisis and its World Repercussions: A Country Study

Due Monday, May 4 at the start of class. Your grade will be based on an essay (8 to 10 pages) and a 5-minute class presentation by one or more members of your group.

In this project you should analyze the Asian economic and currency crisis from the point of view of a particular emerging country that has been affected by the crisis. You should therefore chose an emerging market country (either in Asia or some other region affected by the Asian crisis) and analyze how the crisis in 1997-98 affected the macroeconomy of this country. Among the Asian countries the most interesting case studies are: Thailand, Malaysia, Indonesia, the Philippines, South Korea, Taiwan, China, Hong Kong, Singapore, Vietnam and India. Among other emerging markets that felt the effects of the Asian crisis, you could consider one of the following: Russia, Brazil, Argentina, Peru, Mexico or the Czech Republic. Your mission is to evaluate the economic and business climate of a country from the perspective of a foreign investor. To make this concrete, think of yourself as the country analyst for a firm marketing international mutual funds. A very short example is attached, courtesy of Marco Santamaria of Alliance Capital, but you should feel free to follow a different format if you like. Among the topics/questions you should examine are:

- Did the country experience a currency crisis in 1997-98 (i.e. a speculative attack on its currency that led to the currency depreciation) or not? Was the speculative attack successful in leading to a depreciation or was the country able to defend its currency? Why or why not?

- What are the recent economic indicators, before and after the crisis? Such indicators include:

- Real output growth, inflation, openness, savings,  investment, the balance of trade, the current account and the stock of foreign reserves;

- Exchange rate policy (fixed, floating, or other), including recent or prospective changes;

- The way the current account deficit was financed and the size and composition of external debt (FDI versus borrowing; short-term versus long-term debt, bank versus non-bank borrowing, private versus public sector borrowing, private versus public creditors of the country, currency composition of the borrowing);

- Fiscal policy, including the government deficit;

- Monetary policy, including interest rates and money growth;

- The behavior of the banking system and financial intermediaries including the fragility of the banking system, evidence on the growth rate of lending, the external borrowing behavior of the banks and the amount of non-performing loans.

- The financial conditions of the corporate sector including evidence of excessive borrowing and leverage, overinvestment in the wrong sectors and projects, low profitability of investment.

- Political factors

How did the above factors affect the severity of the crisis in the country you analyze?

Use this information, and anything else you deem relevant, to construct a persuasive argument that your country is currently a good/bad/indifferent place for a large investment with a two year payback period. As usual, you may modify the question if you think it would lead to a more interesting and focused essay.

Data and information sources. You may need to consult a number of sources; I would suggest to start with the following. First, use the information and links available in the homepage on the Asian Economic Crisis. Second, the tables of the International Monetary Fund's International Financial Statistics, published monthly, are a useful source of recent data (you can find this IMF publication in the reference section of Bobst Library, 6th floor). Third, The Economist contains some summary statistics at the end of each issue. Fourth The Economist Intelligence Unit's quarterly and annual country publications (on the 6th floor of Bobst library) provide both economic data and political/historical background. Fifth, the International Monetary Fund publishes country reports on a yearly basis for each member country. You can order the most recent report for a specific country at the price of $15; to order a IMF country report call (202) 623-7430 or check out the publications section of the IMF Web site ( Finally, a lot of country data and information is on the Internet. Use the home pages on Macro Data and Information for links to sites with information. Another good starting point is the WEB Home Page Resources for Economists on the Internet . (URL: