Download International Economics, 7e (Husted/Melvin)

International Economics, 7e (Husted/Melvin)
Chapter 17 Basic Theories of the Balance of Payments
Multiple-Choice Questions
1) If U.S. export contracts are written in terms of foreign currency and import contracts are
denominated in domestic currency, a devaluation of the dollar during the currency contract
period
A) should increase the dollar value of exports.
B) should not have any effect on the dollar value of U.S. imports.
C) must increase the BOT.
D) All of the above
Answer: D
2) The notion that, following a devaluation, the BOT falls for a while before increasing is called
a ________ effect.
A) relative price
B) elasticity
C) J-curve
D) pass-through
Answer: C
3) Suppose that the United Kingdom devalues the pound. If both exports and imports are
written in terms of pounds, then the United Kingdom balance of trade ________ during a
currency contract period.
A) improves
B) worsens
C) is unaffected
D) falls for a while before increasing
Answer: C
4) The ________ analysis considers the ability of domestic and foreign prices to adjust to
devaluation in the short run.
A) pass-through
B) absorption
C) adjustment mechanism
D) currency contract period
Answer: A
5) The shorter the "pass-through" period, the ________ the desirable BOT effects of devaluation
on quantities traded will appear.
A) sooner
B) longer
C) bigger
D) smaller
Answer: A
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6) The balance of trade can only worsen if income ________ relative to absorption.
A) increases
B) decreases
C) does not change
D) None of the above
Answer: B
7) Empirical evidence regarding the effects of devaluation on the balance of trade indicates that
A) devaluation generally improves the BOT.
B) devaluation generally hurts the BOT.
C) no strong generalizations are possible.
D) devaluation has no effect on the BOT.
Answer: C
8) If devaluation does not improve the BOT, but only the BOP, this implies that
A) the capital account is in deficit.
B) the current account is in surplus.
C) the improvement comes in the capital account.
D) Both B and C.
Answer: C
9) Which of the following are theories of the BOT?
A) monetary approach
B) absorption approach
C) elasticities approach
D) Both B and C
Answer: D
10) Which of the following is not appropriate, if we live in a world of fixed exchange rates?
A) monetary approach to the exchange rate
B) elasticities approach
C) monetary approach to the BOP
D) absorption approach
Answer: A
11) With fixed exchange rates, the adjustment to changes in international monetary conditions
comes through
A) exchange rate changes.
B) exchange rate changes and international money flows.
C) international money flows.
D) None of the above.
Answer: C
12) Which of the following is not correct for a small open economy?
A) She cannot improve her BOT.
B) She cannot affect the international price of goods.
C) She cannot affect the foreign interest rate.
D) All of the above.
Answer: A
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13) With fixed exchange rates, an increase in the foreign inflation rate, with constant income and
domestic credit, will lead to
A) a change in the exchange rate.
B) an increase in international reserves.
C) a decrease in international reserves.
D) no change in international reserves.
Answer: B
14) The ________ analyzes the BOP and exchange rates in terms of money supply and money
demand.
A) elasticities approach
B) "pass-through of devaluation"
C) monetary approach
D) absorption approach
Answer: C
15) With a managed float, monetary disequilibrium is eliminated through
A) international reserve flows.
B) exchange rate changes.
C) international reserve flows and exchange rate changes.
D) None of the above.
Answer: C
16) In the case of purely flexible exchange rates, a decrease in domestic real income, with
constant prices and domestic credit, will lead to
A) an increase in international reserves.
B) the depreciation of the domestic currency.
C) the appreciation of the domestic currency.
D) no change in the value of the domestic currency.
Answer: B
17) Under a managed float system, central banks can
A) allow international reserve changes.
B) let exchange rates adjust to market pressure.
C) experience reserve changes and exchange rate changes.
D) All of the above.
Answer: D
18) The ________ is a theory of the balance of trade that emphasizes how domestic spending on
domestic goods changes relative to domestic output.
A) absorption approach
B) monetary approach
C) pass-through analysis
D) elasticities approach
Answer: A
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19) According to the MABP, BOP disequilibria
A) must be transitory.
B) are essentially real phenomena.
C) must be permanent.
D) are not important.
Answer: A
20) Both the ________ do not put a great deal of emphasis on the capital account.
A) absorption and monetary approaches
B) monetary and elasticities approaches
C) elasticities and absorption approaches
D) None of the above
Answer: C
True or False Questions
1) J-curve effects following a devaluation are simply a theoretical issue with no real world
importance.
Answer:
False
Explanation: None Given
2) The longer the "pass-through" period following a devaluation, the faster the desirable
balance of trade effects of a devaluation will appear on quantities traded.
Answer:
False
Explanation: None Given
3) The evidence available suggests that the effects of devaluation appear to differ across
countries and time so that no strong generalizations regarding the effects of devaluation on
the balance of trade and/or balance of payments are possible.
Answer:
True
Explanation: None Given
4) If devaluation improves only the BOP, rather than the BOT, this implies that the capital
account must have improved following a devaluation.
Answer:
True
Explanation: None Given
5) The absorption approach is a theory of the balance of payments that emphasizes how
domestic spending on domestic goods changes relative to domestic output.
Answer:
False
Explanation: None Given
6) The elasticities approach and the absorption approach are theories of the balance of trade
that emphasize trade in real goods and have little to say about the capital account.
Answer:
True
Explanation: None Given
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7) The international adjustment mechanism for flexible exchange rates is the same as for
managed float regimes.
Answer:
False
Explanation: None Given
8) An increase in real income with constant prices and domestic credit leads to the same effects
under both fixed and purely flexible exchange rates.
Answer:
False
Explanation: None Given
9) With a flexible exchange rate, a nation can choose an inflation rate independent of the rest of
the world.
Answer:
True
Explanation: None Given
10) The net effect of a devaluation on economic growth depends on the mix of capital and labor
utilized in the nation's export industries.
Answer:
True
Explanation: None Given
Essay Questions
1) What is the difference between the monetary approach to the exchange rate and monetary
approach to the balance of payments? Briefly summarize the policy implications of the
monetary approach.
Answer: With the MABP there are not exchange rate changes so international reserve flows
respond to changes in PF, Y, and D. With the MAER, there are no reserve flows so the
exchange rate changes in response to changes in PF, Y, and D. Policy implications:
BOP disequilibria are monetary phenomena that are transitory and can be handled
with domestic monetary policy; an increase in domestic income will improve
domestic BOP if not offset by domestic credit increases.
2) Discuss the short-run and long-run views of PPP. Make sure that you explain the
underlying adjustment mechanism and theoretical reasoning for each view when answering
the question. Which view, do you think, is more likely to represent the real world?
Answer: If PPP holds in the short run, then capital flows change money supplies and prices
quickly. If PPP holds only in the long run, then prices must adjust slowly following a
faster adjusting exchange rate.
3) Write down a model that will allow you to analyze the BOP and exchange rate in a monetary
framework. Then, discuss the consequences of an increase in the foreign inflation rate under
fixed, flexible, and managed floating systems.
Answer: R^ - E^ =P^F + Y^ - D^ . If P^F increases, then with fixed rates R^ increases. With a
float, E^ falls. With a managed float, (R^ - E^ ) increases with both R^ increasing and
E^ falling.
4) Is the "international adjustment mechanism" for fixed and flexible exchange rates the same?
Discuss briefly.
Answer: No, the answer to 3 will serve as an acceptable answer.
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5) Explain the elasticities and absorption approaches to the BOT. What is the most notable
shortcoming of these approaches?
Answer: The elasticities approach analyzes the effect of devaluation on the trade balance based
on elasticities of supply and demand for foreign exchange and international trade.
The absorption approach views the trade balance as the difference between what the
economy produces and what it takes for domestic use or absorbs. Neither approach
considers capital flows.
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