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Assessment 2:

In mentioned cases provide a neat diagram to explain your answer. Make sure to label axes properly. Else points will be deducted. The maximum possible points is 40.

  1. The following information is from International Business Times (April 4, 2012)

China has reacted to U.S. QE in the past by expressing dismay, primarily given the overweight U.S. dollar position in their foreign currency reserves.”

(Source: )

Explain the dismay of Chinese government due to quantitative easing (QE) using the FOREX market model discussed in the class. Make sure that you consider the undervalued exchange rate of China while answering the question. Provide neat diagram (s) to explain your answer. (20 points)


Quantitative Easing is basically defined as the introduction of new money supply to the economy as a way to control the value of a currency or deal with a internal money supply in an economy. Quantitative Easing (Q.E.) is an underlying expectation of the usual open market operations business. While the open market operation is meant to increase the money supply while on the other hand decreasing interest rates in order to stimulate and advance the economy, the method is limited effect when short-term interest rates are near or below zero. To lessen and make the effects of the zero bound Q.E. is implemented. This is done mostly through private sector assets that have way longer maturity and commercial banks. Q.E. is also used to reduce the value of the currency, stimulating the economic activity by making exports from specific countries.


The graph above shows a replica of what is expected once Q.E. measures are introduced to China. Due to policies by the USA Federal Reserve and the government of Germany, China would have to install measures to ensure its competitiveness in the international market. This also works as an advantage to China as its exports and other services from China come at a relative cheaper price compared to the European nations or America. However, due to actions taken under the Q.E. mechanism, particularly, the buying of the Euro from South America’s Brazil, the price of the Euro against the dollar will definitely rise.

  1. Let’s assume the following information for an economy.


[All the notations are standard as discussed in the class]

  1. Find the size of the multiplier in this economy. (3 points)


1000 + 0.6Y = C

AD = 10000 + 2000 + 5000 + 600 – 400 + 0.6Y

= 17,200 + 0.6Y

  1. Find the short run equilibrium output. (7 points)


1000 + 0.6Y = C

Y = 10,000 + 2000 + 5000 + 600 – 400 + 0.6Y

Y = 17,200/0.4

  1. The following news was issued in Bloomberg.

“Thailand’s baht fell for a second week to reach the lowest level since 2010 and the benchmark stock index led losses in Southeast Asia on concern worsening political unrest will spur further capital outflows”.

( )

  1. Why do you think that there is going to be capital outflow? (3 points)


Capital outflow is the amount of money exiting an economy. There are several reasons why money leaves an economy, mostly drive by political and economic factors. In one day the country lost $77.6 million in shares. Furthermore, Thailand has had an outflow of $6.2 billion in equities within the year. With a continuous political volatility within the country, these figures are only expected to rise and loss of investor confidence, hence capital outflow from the economy.

  1. If indeed there is going to be huge capital flight, what should be the policy taken up by Bank of Thailand to avoid a free fall of their exchange rate and how they can achieve it (explain at least one instrument)? (5+2=7 points)


First, the bank can place a restriction of forward transactions. Forward transactions are purchases made at certain preset prices for delivery at another date. Forward transactions include all transactions including forward contracts in the stock, financial and money markets.

Export surrenders requirements are critical since they provide a mechanism that rids the economy of foreign currency.

Proceeds from sale of shares converted at the onshore exchange rate

Close all avenues of trading of the national currency so as to avoid investors and fund managers from taking advantage of the freefall of the economy.

Provide a limit on the international convertibility of the proceeds from the sale of Thai securities.