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Developing Countries: Growth, Crisis, and Reform
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International Economics Study Set 8

Business

Quiz 21 :
Developing Countries: Growth, Crisis, and Reform

Quiz 21 :
Developing Countries: Growth, Crisis, and Reform

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Can a government always collect more seigniorage simply by letting the money supply grow faster? Explain your answer.
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Seigniorage is profit from money creation (that is printing money), a way for governments to generate revenue without levying conventional taxes.
Under fiat money system, the product of the inflation rate and the inflation tax base gives seigniorage revenue.
Mathematically expressed as:
img The inflation tax base is the level of real money balances that reflects the purchasing power of the public's money holdings.
img Remember, rapid monetary expansion causes the inflation rate to rise, but the revenue effects are offset, as individuals attempt to spend the extra money, quickly before it depreciates further.
If people spend more money than being printed, the rate of price increase exceeds the rate of money issued.
Therefore, an attempt to raise seigniorage revenue not only leads to inflation, but also eventually is self-defeating.

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Assume that a country's inflation rate was 100 percent per year in both 1990 and 2000 but that inflation was falling in the first year and rising in the second. Other things equal, in which year was seigniorage revenue greater? (Assume that asset holders correctly anticipated the path of inflation.)
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Answer:

Answer:

Seigniorage is profit from money creation (that is printing money), a way for governments to generate revenue without levying conventional taxes.
Under fiat money system, the product of the inflation rate and the inflation tax base gives seigniorage revenue.
Mathematically expressed as:
img The inflation tax base is the level of real money balances that reflects the purchasing power of the public's money holdings.
img Therefore, a higher inflation rate leads to lower levels of real money balances and vice-versa.Given that:
• Inflation rate in the year 1990 and 2000 is 100%
• It was falling in the 1 st year and rising in the 2 nd year.
Since the asset holders, have correctly anticipated the path of inflation, the real money balances of the people will be more. As a result, seigniorage revenues will be less.
Similarly, in the year 2000, though the inflation rate is rising, the real balances of the people will fall. As a result, the seigniorage revenue will be greater.

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In the early 1980s, Brazil's government, through an average inflation rate of 147 percent per year, got only 1.0 percent of output as seigniorage, while Sierra Leone's government got 2.4 percent through an inflation rate less than a third as high as Brazil's. Can you think of differences in financial structure that might partially explain this contrast? (Hint: In Sierra Leone, the ratio of currency to nominal output averaged 7.7 percent; in Brazil, it averaged only 1.4 percent.)
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Seignior-age revenue refers to the product of inflation rate and the real money balances held by the people. Higher is the inflation rate, lower is the real money balances level; therefore lower is the seigniorage revenues.
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Since Brazil's inflation rate is at 147 percent, its real money balance holdings will be reduces so as to reduce its seigniorage revenue. While Sierra Leone's inflation rate is less than one-third of that of Brazil, that is 49 percent, its real money balance holdings will be increased so as to increase its seigniorage revenue.
Relatively Brazil's seignior-age revenue as a percentage of output (1.0%)is lesser than that of Sierra Leone (2.4%). Now the difference in seigniorage revenue for both the countries reflects a difference in the financial structure in both the countries.
The contrasting fact is that nominal money holdings in Sierra Leone (7.7%)is much more than that of Brazil (1.4%)along with the given inflation rates implies that the Brazil has less real money holdings.

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Suppose an economy open to international capital movements has a crawling peg exchange rate under which its currency is pegged at each moment but is continuously devalued at a rate of 10 percent per year. How would the domestic nominal interest rate be related to the foreign nominal interest rate? What if the crawling peg is not fully credible?
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The external debt buildup of some developing countries (such as Argentina) in the 1970s was due, in part, to (legal or illegal) capital flight in the face of expected currency devaluation. (Governments and central banks borrowed foreign currencies to prop up their exchange rates, and these funds found their way into private hands and into bank accounts in New York and elsewhere.) Since capital flight leaves a government with a large debt but creates an offsetting foreign asset for citizens who take money abroad, the consolidated net debt of the country as a whole does not change. Does this mean that countries whose external government debt is largely the result of capital flight face no debt problem?
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Much developing-country borrowing during the 1970s was carried out by state- owned companies. In some of these countries, there have been moves to privatize the economy by selling state companies to private owners. Would the countries have borrowed more or less if their economies had been privatized earlier?
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How might a developing country's decision to reduce trade restrictions such as import tariffs affect its ability to borrow in the world capital market?
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Given output, a country can improve its current account by cutting either investment or consumption (private or government). After the debt crisis of the 1980s began, many developing countries achieved improvements in their current accounts by cutting investment. Was this a sensible strategy?
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Why would Argentina have to give the United States seigniorage if it gave up its peso and completely dollarized its economy? How would you measure the size of Argentina's sacrifice of seigniorage? (To complete this exercise, think through the actual steps Argentina would have to take to dollarize its economy. You may assume that the Argentine central bank's assets consist of 100 percent of interest- bearing U.S. Treasury bonds.)
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Early studies of the economic convergence hypothesis, which looked at data for a group of currently industrialized countries, found that those that were relatively poor a century ago subsequently grew more quickly. Is it valid to infer from this finding that the convergence hypothesis is true?
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Some critics of the adoption of fixed exchange rates by emerging market economies argue that these exchange rates create a kind of moral hazard. Do you agree? (Hint: Might borrowers behave differently if they knew exchange rates were changeable from day to day?)
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In some emerging market economies, not only are debt obligations to foreigners denominated in dollars, but so are many of the economies' internal debts, that is, debts of one domestic resident to another. In the chapter, we called this phenomenon liability dollarization. How might liability dollarization worsen the financial market disruption caused by a sharp depreciation of the domestic currency against the dollar?
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Suppose the production function for aggregate output in the United States is the same as in India, Y = AK ? L 1 ?? , where A is a total productivity factor, K is the capital stock, and L is the supply of labor. From Table, calculate the ratio of per capita incomes Y/L in India and the United States in 2010. Use this information to figure out the ratio of capital's marginal product in India and the U.S. (The marginal product of capital is given by ? AK ??1 L 1??.) Relate the answer to the Lucas puzzle of capital flows from rich to poor. How much would A have to differ between India and the U.S. to make the marginal product of capital the same in the two countries? img
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