978-1259578113 Chapter 11 Solutions Manual

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OPENING CASE: The IMF and Ukraine’s Economic Crisis

The opening case explores the economic impact of political unrest in Ukraine and the IMF’s role

in restoring stability. In 2013, Ukraine president Viktor Yanukovych pulled the country out of a

trade deal with the European Union in order to strengthen political ties to Russia. Pro-Western

forces in Ukraine protested the decision and removed Yanukovych from office. Russia annexed

the Crimea region of Ukraine in early 2014, sparking civil war that led to economic collapse. The

IMF extended two loans to Ukraine in 2014 and 2015 on the condition that the country used the

funds to support the value of the hryvina, maintained a floating exchange rate, ended oil and gas

subsidies, and instituted a tight monetary policy. The loans, along with additional support from

the United States and European Union, were expected to promote economic growth in Ukraine

by 2016. Discussion of the case can revolve around the following questions.

QUESTION 1: Why was it important for the IMF to step in to help Ukraine? What were the

potential implications of Ukraine’s economic crisis for other countries?

QUESTION 2: How did the IMF help Ukraine? What impact did it have the country’s economy

and prospects for future growth?

QUESTION 3: Discuss the IMF’s approach to shoring up Ukraine’s economy via austerity

measures. What are the expected effects of such measures? Are they likely to lead to economic

growth?

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CRITICAL THINKING AND DISCUSSION QUESTIONS

QUESTION 1: Why did the gold standard collapse? Is there a case for returning to some type of

gold standard? What is it?

ANSWER 1: The gold standard worked reasonably well from the 1870s until the start of World

War I in 1914, when it was abandoned. During the war several governments financed their

massive military expenditures by printing money. This resulted in inflation, and by the war’s end

QUESTION 2: What opportunities might current IMF lending policies to developing nations

create for international businesses? What threats might they create?

ANSWER 2: The IMF lending policies require the recipient countries to implement

QUESTION 3: Do you think the standard IMF policy prescriptions of tight monetary policy and

reduced government spending are always appropriate for developing nations experiencing a

currency crisis? How might the IMF change its approach? What would the implications be for

international business?

QUESTION 4: Debate the relative merits of fixed and floating exchange rate regimes. From the

perspective of an international business, what are the most important criteria for choosing

between the systems? Which system is the more desirable for an international business?

QUESTION 5: Imagine that Canada, the United States, and Mexico decide to adopt a fixed

exchange rate system. What would be the likely consequences of such a system for (a)

international businesses, and (b) the flow of trade and investment among the three countries?

QUESTION 6: Reread the Country Focus on the U.S. dollar, oil prices and recycling

petrodollars, then answer the following questions:

a. What will happen to the value of the U.S. dollar if oil producers decide to invest most of their

earnings from oil sales in domestic infrastructure projects?

b. What factors determine the relative attractiveness of the dollar-, euro-, and yen-denominated

assets to oil producers flush with petrodollars? What might lead them to direct more funds

toward non-dollar-denominated assets?

c. What will happen to the value of the U.S. dollar if OPEC members decide to invest more of

their petrodollars towards non-dollar assets, such as euro denominated stocks and bonds?

d. In addition to oil producers, China is also accumulating a large stock of dollars, currently

estimated to total $1.4 trillion. What would happen to the value of the dollar if China and

oil-producing nations all shifted out of dollar-denominated assets at the same time? What would

be the consequences for the United States economy?

CLOSING CASE: The IMF and Iceland’s Economic Recovery

The closing case explores the economic recovery of Iceland following loans from the

International Monetary Fund (IMF) and from various countries. Iceland’s three biggest banks

had been expanding at a breakneck pace since 2000 until the global crisis in 2008. The Icelandic

banks, in their swift growth period, started to expand into other Scandinavian countries and the

United Kingdom by offering high interest rates to foreign depositors. The banks also entered

local mortgage markets. When financial markets froze around the world in 2008, the banks were

no longer able to refinance the large amount of debt they held. In the aftermath of the resulting

financial crisis, Iceland was able to stabilize its economy with IMF loans and a floating currency

rate. Discussion of the case can revolve around the following questions:

QUESTION 1: What were the main causes of Iceland’s currency troubles in 2008?

QUESTION 2: Was Iceland facing a classic currency crisis, or was this a banking crisis?

depositors.QUESTION 3: How did Iceland recover from its 2008–2009 crisis? What are the

important lessons to draw from this case?

ANSWER 3: Iceland recovered from its economic crisis through a combination of IMF loans, a

fiscal policy intended to maintain consumer spending, and surging exports. The IMF loans, in

QUESTION 4: Iceland did not implement the austerity policies that are so often associated with

IMF loans, and yet the economy recovered. Does this suggest that austerity policies do not work?

ANSWER 4: Not necessarily. Iceland was able to recover without implementing austerity

INCORPORATING globalEDGE™ EXERCISES

Use the globalEDGE™ website {globaledge.msu.edu/} to complete the following exercises:

Exercise 1

The Global Financial Stability Report is a semiannual report published by the International

Capital Markets division of the International Monetary Fund (IMF). The report includes an

assessment of the risks facing the global financial markets. Locate and download the latest report

to get an overview of the most important issues currently under discussion. Also, download a

report from five years ago. How do the issues from five years ago compare with financial issues

identified in the current report?

Exercise 1 Answer

Additional Info:

The report is published semi-annually by the Capital Markets Division of the International

Monetary Fund and examines current risks facing the global financial system and policy actions

that may mitigate these. As a result it provides a great overview of the state of the global

financial system.

Exercise 2

An important element to understanding the international monetary system is keeping updated on

current growth trends worldwide. A German colleague told you yesterday that Deutsche Bank

Research provides an effective way to stay informed on important topics in international finance

from a European perspective. Find an emerging market research report for analysis. On which

emerging market region did you choose to focus? What are the key takeaways from your chosen

report?

Exercise 2 Answer

Additional Info:

A research-focused website published by the Deutsche Bank, the site provides timely analysis of

the international finance markets. A special section is dedicated to Emerging Markets and can be

reached under the “Research” section of the main navigation.