instructions:Klaus DesmetInternational Macro & Policy
Problem Set 4
Due Date: Thursday 24 March in Class
1. Consider two countries, the US and Mexico, and two sector, tradeables and nontradeables.
Productivity (TFP) in tradeables is AT in the US and A∗
T
in Mexico, whereas
productivity (TFP) in nontradeables in ANT in the US and A∗
NT in Mexico. The
share of tradeables in spending, γ, is equal to 0.5. Use the Balassa-Samuelson model
we studied in class to answer the following questions.
(a) Compute the price level of Mexico relative to the US if AT = 2A∗
T
and ANT =
A∗
NT .
(b) Compute the price level of Mexico relative to the US if AT = A∗
T
and ANT =
A∗
NT .
(c) What will happen to the Mexican price level relative to the US price level when
the technological gap between both countries narrows?
2. This question is for one point extra credit. Explore the uncovered interest parity
condition in the data. To do so,
(a) Go to the World Development Indicators, and download for 3 countries and 20
years (1980-2000) the deposit interest rate and the official exchange rate with
the U.S. dollar. Then download the 1 year treasury bill interest rate from the
Federal Reserve website.
(b) For the 3 different country pairs (one of the two countries in each pair is the
U.S.) and years, create the following two variables: Rit − R$t
(the difference in
the deposit interest rates between country i and the US for year t) and (Ei$,t+1 −
Ei$,t)/Ei$,t (the change in the exchange rate of currency i versus $ between year
t and year t + 1).
(c) Make one scatter plot in Excel for all pairs together with (Ei$,t+1 − Ei$,t)/Ei$,t
on the y-axis and Rit − R$t on the x-axis. That is, the scatter plot should have
57 points (3 country pairs times 19 observations per country).
1
(d) Draw a regression line in Excel and look at the coefficient on the slope. What
does that tell you about UIP?
(e) Rather than analyzing different country pairs together, now draw 3 separate
scatter plots (each 19 observations), with in each a regression line. Discuss your
findings.
Note: for this last question, I only need to see parts c), d) and e). Please print out
your Excel graphs and your comments on them.