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INTERNATIONAL FINANCE
Assignment Problems (11)
Name:
Student#:
I. Choose the correct answer for the following questions (only ONE correct
answer) (2 credits for each question, total credits 2 x 30 = 60)
1. The most widely used index to measure a country’s inflation is __________.
A. Producer Price Index (PPI)
B. Consumer Price Index (CPI)
C. Real Exchange Rate Index
D. GDP deflator
2. Which of the following objectives is a government tries to achieve?
A. low inflation rate
B. low unemployment rate
C. high growth rate
D. all of the above are the objectives a government tries to achieve in an economy.
3. Which of the following objectives is concerned for a government in terms of external balance?
A. keeping inflation under check
B. maintaining a sustainable growth rate
C. restoring BOP equilibrium if disequilibrium occurs
D. limiting the size of business cycle fluctuations
4. High unemployment rate means __________.
A. a lot of people who are looking for a job can’t get a job
B. the economy may not be using some of its resources efficiently
C. something wrong with the way the economy operates
D. all of the above are true
5. High capital mobility indicates __________.
A. the steep BP curve
B. the flat BP curve
C. the vertical BP curve
D. the horizontal BP curve
6. Low capital mobility implies that __________.
A. the difference between domestic interest rate and foreign interest rate has little effects on the
capital movement between nations
B. the domestic residents are absolutely not allowed to buy foreign securities
C. the foreign residents are absolutely not allowed to buy domestic securities
D. there is no foreign investment in the country where capital movements are controlled
7. Perfect capital mobility, showed by a figure, is a __________.
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A. steep curve
B. flat curve
C. vertical curve
D. horizontal curve
8. A monetary contraction implies __________.
A. interest rate will be down
B. price of securities will be high
C. domestic currency possibly appreciates in the foreign exchange market
D. all of the above are true
9. Which of the following does NOT belong to the expansionary monetary policy?
A. The central bank purchases government bonds.
B. The central bank lowers reserve ratio.
C. The government increases budget deficits.
D. The central bank decreases discount rate.
10. To maintain a fixed exchange rate, a central bank facing BOP deficit can __________.
A. sell foreign currencies in the foreign exchange market
B. purchase securities through open market operations
C. reduce the interest rate at which it lends money to commercial banks
D. all of the above
11. The locomotive effect refers to the situation that __________.
A. a reduction in interest rate brings an increase in income
B. an increase in income in one nation brings an increase in income in another nation
C. an expansionary fiscal policy causes the increase in income
D. an expansionary monetary policy generates high income
12. The beggar-thy-neighbor effect means __________.
A. the expansionary fiscal policy crowds out part of the investment spending
B. the expansionary fiscal policy generates BOP deficit
C. an increase in income in one nation is at the cost of reduction in income in another nation
D. an increase in income in one nation causes an increase in interest rate in another nation
13. Country A adopts fixed exchange rate system and restricts some part of the transactions under
the capital account. What effect does the expansionary fiscal policy have on the domestic
economy?
A. interest rate goes up
B. domestic currency depreciates in the foreign exchange market
C. national income declines
D. unemployment rate rises
14. Country B does not put any restrictions on capital account transactions. What is NOT true
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regarding the effect of expansionary monetary and fiscal policies if country B uses the fixed
exchange rate system?
A. interest rate remains the same as before
B. national income rises
C. domestic currency appreciates in the foreign exchange market
D. unemployment rate goes down
15. Before 1971 most countries adopted fixed exchange system. Suppose the U.S. increased
government spending and lowered tax rates. The income of its neighbor, Canada would be reduced.
Economist described this phenomenon as “__________”.
A. crowding out effect
B. beggar-thy-neighbor effect
C. locomotive effect
D. signaling effect
16. An appreciation of the value of a country’s currency under floating exchange rate possibly
leads to __________.
A. the shift of IS curve to the right
B. the shift of IS curve to the left
C. the shift of LM curve to the right
D. the shift of LM curve to the left
17. The impact of a depreciation of the domestic currency on BP curve under the floating
exchange rate system is that __________.
A. the slope of BP curve increases
B. the slope of BP curve decreases
C. the BP curve shifts to the right
D. the BP curve shifts to the left
18. In a two-country model with floating exchange rate and perfect capital mobility, the effect of
changes in monetary policy on the domestic economy is __________ by subsequent changes in
the exchange rate and foreign income
A. completely offset
B. reduced
C. magnified
D. unaffected
19. Which of the following statements is TRUE in a small open economy with perfect capital
mobility?
A. Monetary policy is less effective with floating exchange rates than it is with fixed exchange
rates.
B. Monetary policy is more effective with floating exchange rates than it is with fixed exchange
rates.
C. Both monetary and fiscal policies are more effective with fixed exchange rates than with
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floating exchange rates.
D. Both monetary and fiscal policies are more effective with floating exchange rates than with
fixed exchange rates.
20. In a small open economy with perfect capital mobility, __________.
A. monetary policy has its largest possible income effects when the exchange rate floats.
B. fiscal policy has its largest possible income effects when the exchange rate floats.
C. monetary and fiscal policies are both ineffective when the exchange rate floats.
D. fiscal policy has minimal income effects when the exchange rate is fixed.
21. Which of the following policies will create a beggar-thy-neighbor effect in a floating exchange
rate system?
A. a domestic fiscal expansion in a small open economy
B. a domestic fiscal expansion in the two-country model
C. a domestic monetary expansion in the two-country model
D. a domestic monetary expansion in a small open economy
22. Which of the following policies will create a locomotive effect in a floating exchange rate
system?
A. a domestic fiscal expansion in a small open economy
B. a domestic fiscal expansion in the two-country model
C. a domestic monetary expansion in the two-country model
D. a domestic monetary expansion in a small open economy
23. In a two-country model with floating exchange rates, a foreign monetary expansion leads to
__________.
A. no changes in either the interest rate or domestic income
B. a lower interest rate and lower domestic income
C. a higher interest rate and lower domestic income
D. a lower interest rate and an increase in domestic income
24. In the two-country model with floating exchange rates, a domestic fiscal expansion
__________.
A. leads to a decrease in foreign income because the expansion causes an appreciation of the
domestic currency, which causes an increase in the net exports of the foreign economy.
B. leads to a decrease in foreign income because the expansion lowers the interest rate, and thus
spurs investment in the foreign country.
C. leads to a decrease in foreign income because the expansion leads to a higher interest rate,
which induces a rightward shift in the foreign LM schedule.
D. does not lead to a decrease in foreign real income.
25. An increase in the demand for money that is not caused by a change in income will shift the
__________.
A. LM curve to the right
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B. IS curve to the right
C. LM curve to the left
D. IS curve to the left
II. Problems (50 credits)
1. Assume country A prohibits any kind of capital flows across its borders. Draw the BP curve
for country A. If the government expands its spending and cut tax rates, what effects will have
on the aggregate output in such an environment? (8 credits)
2. The degree of capital mobility is a crucial determinant of the initial impacts on a country’s
BOP and equilibrium national income level. Show how fiscal contraction with different
degree of capital mobility affects economy under the fixed exchange rate system. (8 credits)
3. In a two-country model both countries fixed their exchange rates. The domestic central bank
uses unsterilized foreign exchange market intervention to defend exchange rate. Work out the
effects of a foreign fiscal contraction. (8 credits)
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4. The government of a small open economy with relatively low capital mobility and a floating
exchange rate decides that its top policy objective is to reduce its budget deficit via a
reduction in government expenditures. Trace through the likely effects of this policy action
within the IS-LM-BP framework. (8 credits)
5. The central bank of a small open economy with relatively high capital mobility and a floating
exchange rate implements a contractionary monetary policy. Trace through the likely effects
of this policy action within the IS-LM-BP framework. (8 credits)
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