1.     Carefully explain why the discovery of oil in Norway led to several periods of deficit in Norway's current account followed by periods of surplus in the current account.

2.     What is meant by the term domestic absorption (A)? Why is the current account equal to the difference between national income and A? Why is the current account also equal to the difference between savings and investment? Explain. Why is the current account also equal to the change in net foreign assets? Explain.

3.     Consider a small open economy with zero government spending. Suppose that at the world interest rate, this economy runs a current account balance equal to zero. Now suppose that current government spending increases, but future government spending is unchanged. All government spending is used for government consumption. What will happen to the current account balance in this economy today? What will happen to the current account balance next period (assume a two-period model)? Explain.

4.     Consider the same economy as in the previous problem, but now assume that government spending increases by the same amount in both periods. How is your answer changed? Explain.

5.     Suppose that for country X the official reserves settlements balance is (always) equal to zero. Then if country X runs a current account deficit what must be the status of its capital account balance? Explain in words what is happening to the capital account balance given the current account deficit.

6.     Consider the two-country model of interest-rate determination with savings and investment. Suppose that at the initial world interest rate the home country has a current account surplus. Draw the savings-investment diagram and the equilibrium world interest rate for both countries.
        Now suppose that preferences in the home country shift so that savings declines at every interest rate (in the home country). What happens to the equilibrium world interest rate? What happens to the equilibrium levels of savings and investment in the home country? What happens to savings and investment in the foreign country?

7.     Use the same model as in the previous question. Suppose that at the initial world interest rate the current account balance in the home country is zero. Draw the savings-investment diagram and the equilibrium world interest rate for both countries.
         Now suppose that in the home country the productivity of capital in period 2 has increased. For example, an invention is discovered today that, it is announced, will raise the productivity of home country capital in period 2. What will happen to investment in the home country in period 1? What will happen to home country savings in period 1? What happens to the equilibrium world interest rate and the current account balances in the two countries?

8.    In the mid-1980's Brazil had fairly large trade surpluses yet it ran persistent large current account deficits. How is this possible? Explain.

9.    From 1990 through 1996 Thailand experienced large current account deficits of approximately 8 to 9% of GDP. Subsequently, the current account has gone into a surplus of about 8% of GDP. Why has this shift been associated with a sharp recession in Thailand?

10.    College students typically run current account deficits. After graduation their current accounts eventually go into surplus. Given the experience of Thailand (discussed in the previous question) does this mean that college graduates go into recessions? What is the key difference in the two situations? Explain.

11.    Trace the effects on the balance of payments of the following:
             i)    an increase in exports of computers to France paid for by checks written on French banks.
            ii)    an increase in direct foreign investment by US firms in Hungary.

12.    Carefully explain the difference between covered interest parity and uncovered interest parity. Which is more likely to be observed? Explain.

13.    What is the difference between a forward contract for foreign exchange and a futures contract for foreign exchange?

14.    Why does a positive forward premium mean that the domestic currency is expected to depreciate? Explain.

15.    Suppose that the uncovered interest parity condition holds. If domestic interest rates exceed foreign interest rates, what does the market expect to happen to the value of the domestic currency? Explain.

16.    Suppose that in the US we make large gas guzzling autos while in Japan they make small, energy-conserving autos. If oil prices suddenly increase, what will happen to the US real exchange rate? Explain.