Download STUDY GUIDE FINAL ECO41 FALL 2011 UDAYAN ROY The final

STUDY GUIDE FINAL ECO41 FALL 2011 UDAYAN ROY
The final test will be held on Wednesday, December 21, 8:00 – 10:40. It will consist of multiple-choice
questions. The chapter-by-chapter tally of questions is as follows:
Textbook Chapter
13
14
15
16
17
18
20
Total
# of Final Questions
6
4
3
15
12
6
8
54
The questions will be based on Chapters 1 – 12 of my lecture notes, and the following sections of the
course’s textbook:
Chapter 13:
all of it
Chapter 14:
Exchange Rates and International Transactions
The Demand for Foreign Currency Assets
Equilibrium in the Foreign Exchange Market
Interest Rates, Expectations, and Equilibrium
My PowerPoint lecture notes on this chapter should be helpful
Chapter 15:
Aggregate Money demand,
The Equilibrium Interest Rate: The Interaction of Money Supply and Money demand,
Money, the Price Level, and the Exchange Rate in the Long Run
My PowerPoint lecture notes on this chapter should be helpful
Chapter 16:
The Law of One Price
Purchasing Power Parity
A Long-Run Exchange Rate Model Based on PPP
Beyond Purchasing Power Parity: A General Model of Long-Run Exchange Rates
International Interest Rate Differences and the Real Exchange Rate, Real Interest Parity
My PowerPoint lecture notes on this chapter should be helpful
Chapter 17:
Determinants of Aggregate Demand in an Open Economy
The Equation of Aggregate Demand
How Output Is determined in the Short Run
Output Market Equilibrium in the Short Run: The DD Schedule
Asset Market Equilibrium in the Short Run: The AA Schedule
Short-Run Equilibrium for an Open Economy
Temporary Changes in Monetary and Fiscal Policy
My PowerPoint lecture notes on this chapter should be helpful
Chapter 18:
How the Central Bank Fixes the Exchange Rate
Stabilization Policies with a Fixed Exchange Rate
My PowerPoint lecture notes on this chapter should be helpful
Chapter 20:
The Theory of Optimum Currency Areas
The Future of EMU
My PowerPoint lecture notes on this chapter should be helpful
A copy of the textbook is on reserve at the library’s circulation desk.
Very Important: I will be posting practice questions on the course’s Web site at
http://myweb.liu.edu/~uroy/eco41/index.html, both this week and next week. Many of these practice
questions may reappear in the final. You will have to find the answers on your own. Please also visit the
web page to check your records. Please let me know if you see any errors.
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Chapter 13: National Income Accounting: please review the questions in Quiz 3
Chapter 13: Balance of Payments Accounting: please review the questions in Quiz 4
Chapter 14: Foreign exchange market
How many dollars would it cost to buy an Edinburgh Woolen Mill sweater costing £50 if the exchange
rate is $1.50 per one British pound (£)? $_________
How many dollars would it cost to buy an Edinburgh Woolen Mill sweater costing 50 British pounds if
the exchange rate is 1.80 dollars per one British pound? $______
If the price of a British pound increases from $1.50 per pound to $1.80 per pound, we say that:
a.
b.
c.
d.
The dollar has appreciated and the pound has depreciated
the dollar has depreciated and the pound has appreciated
the dollar has appreciated and the pound has appreciated
the dollar has depreciated and the pound has depreciated
When the price of a British pound increases from $1.50 per pound to $1.80 per pound,
a. Americans find that Britain’s exports are more expensive, and British residents find that imports
from America are more expensive.
b. Americans find that Britain’s exports are more expensive, and British residents find that imports
from America are less expensive.
c. Americans find that Britain’s exports are cheaper; however, British residents are not affected.
d. Americans are not affected, but British residents find that imports from America are more
expensive.
e. None of the above.
An appreciation of a country’s currency
a.
b.
c.
d.
e.
Decreases the relative price of its exports and lowers the relative price of its imports.
Raises the relative price of its exports and raises the relative price of its imports.
Lowers the relative price of its exports and raises the relative price of its imports.
Raises the relative price of its exports and lowers the relative price of its imports.
None of the above.
The exchange rate between currencies depends on
a. The interest rates that can be earned on deposits in those currencies.
b. The expected future exchange rate.
c. The interest rates that can be earned on deposits in those currencies and the expected future
exchange rate.
d. National output.
e. None of the above.
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If the interest rate on dollar deposits is 10 percent and the interest rate on euro deposits is 6 percent,
then
a.
b.
c.
d.
An investor should invest only in dollar deposits.
An investor should invest only in euro deposits.
An investor should be indifferent between dollar deposits and euro deposits.
It is impossible to tell given the information.
Which of the following statements is the most accurate?
a.
b.
c.
d.
A rise in the interest rate on dollar bank deposits (R$) causes the dollar to appreciate.
A rise in the interest rate on dollar bank deposits (R$) causes the dollar to depreciate.
A rise in the interest rate on dollar bank deposits (R$) does not affect the U.S. dollar.
For a given euro interest rate (R€) and constant expected exchange rate (Ee$/€), a rise in the
interest rate on dollar deposits (R$) causes the dollar to appreciate.
e. None of the above.
If the interest rate paid by US banks (R$) is 6 percent and the interest rate paid by European banks (R€) is
4 percent, the theory of interest parity says that people probably expect
a.
b.
c.
d.
The dollar to appreciate by 2 percent
The euro to appreciate by 2 percent
The dollar to appreciate by 10 percent
The euro to appreciate by 10 percent
What is equation that represents the interest parity condition?
a.
b.
c.
d.
R$ = R€ + (Ee$/€ – E$/€) / E$/€.
R€ = R$ + (Ee$/€ – E$/€) / E$/€.
R$ = R€ + (Ee€/$ – E€/$) / E€/$.
R$ = R€ - (Ee$/€ – E$/€) / E$/€.
If all interest rates stay unchanged, the theory of interest parity says that an increase in the expected
future value of the euro (Ee$/€)
a.
b.
c.
d.
Will cause the value of the euro (E$/€) to increase immediately
Will cause the value of the euro (E$/€) to decrease immediately
Will have no immediate effect on the value of the euro (E$/€)
Will cause the value of the euro (E$/€) to increase, but only in the long run
When the interest parity equation is satisfied,
a.
b.
c.
d.
e.
The goods market is in equilibrium
The money market is in equilibrium
The foreign exchange market is in equilibrium
All of the above
None of the above
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Chapter 15: Money market
The aggregate money demand (Md) depends on
a. The interest rate (R)
b. The price level (P)
c. Real national income (Y)
d. All of the above.
e. Only (a) and (c)
The aggregate money demand (Md) _____ when Y increases, _______ when R increases, and ______
when P increases. Fill in the blanks using any or all of the following answers: increases,
decreases, stays unchanged.
The requirement that the real supply of money (Ms/P) must equal the real demand for money (L) implies
that the domestic interest rate (R) will rise if:
a. Ms↓ or P↑ or Y↑ or some combination of these changes occurs.
b. Ms↑ or P↓ or Y↑ or some combination of these changes occurs.
c. Ms↑ or P↓ or Y↓ or some combination of these changes occurs.
d. None of the above.
A rise in
a. real GNP (Y) decreases aggregate real money demand (L) for any given interest rate (R), thereby
moving the L(R,Y) curve to the right.
b. real GNP raises aggregate real money demand for any given interest rate, moving the L(R,Y) curve to
the left.
c. real GNP raises aggregate real money demand for any given interest rate, moving the L(R,Y) curve to
the right.
d. nominal GNP raises aggregate real money demand for a given interest rate, moving the L(R,Y) curve to
the right.
e. real GNP raises aggregate nominal money demand for a given interest rate, moving the L(R,Y) curve to
the right.
The real money supply (Ms/P) curve is
a. horizontal because MS is set by the central bank while P is taken as given.
b. vertical because MS is set by the central bank.
c. vertical because MS is set by the households and firms while P is taken as given.
d. horizontal because MS and P are set by the central bank.
e. vertical because MS is set by the central bank while P is taken as given.
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Interest
Rate, R
Interest
Rate, R
Real Money
Holdings
Real Money
Holdings
Which of the following is accurate?
a. As the left panel of the figure above shows, an increase in the supply of money reduces the interest
rate, provided the price level and the real GNP are unchanged.
b. As the right panel of the figure above shows, an increase in the supply of money raises the interest
rate, provided the price level and the real GNP are unchanged.
c. As the left panel of the figure above shows, an increase in the supply of money raises the interest
rate, provided the price level and the real GNP are unchanged.
d. As the right panel of the figure above shows, an increase in the supply of money reduces the interest
rate, provided real GNP is unchanged.
e. None of the above.
Which of the following is accurate?
a. As the left panel of the figure above shows, an increase in real GNP reduces the interest rate,
provided the price level and the supply of money are unchanged.
b. As the right panel of the figure above shows, an increase in real GNP raises the interest rate, provided
the price level and the supply of money are unchanged.
c. As the left panel of the figure above shows, an increase in real GNP raises the interest rate, provided
the price level and the supply of money are unchanged.
d. As the right panel of the figure above shows, an increase in real GNP reduces the interest rate,
provided the supply of money is unchanged.
e. None of the above.
The requirement that the real supply of money (Ms/P) must equal the real demand for money (L) implies
that the domestic interest rate (R) will rise if:
a. Ms↓ or P↑ or Y↑ or some combination of these changes occurs.
b. Ms↑ or P↓ or Y↑ or some combination of these changes occurs.
c. Ms↑ or P↓ or Y↓ or some combination of these changes occurs.
d. None of the above.
We saw in the discussion of interest parity in Chapter 14 that R = R* + (Ee – E)/E, where R is the domestic
interest rate, R* is the foreign interest rate, and Ee is the expected future value of the foreign currency.
This implies that the value of the foreign currency (E) will rise if:
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a. R↓ or R*↑ or Ee↑ or some combination of these changes occurs.
b. R↑ or R*↑ or Ee↑ or some combination of these changes occurs.
c. R↓ or R*↑ or Ee↓ or some combination of these changes occurs.
d. None of the above.
Combining the themes of Chapter 14 and of this chapter that were discussed in the last 2 questions, we
can say that the value of the foreign currency (E) will rise if:
a. Ms↓ or P↑ or Y↑ in the US, or Ee↑ or some combination of these changes occurs.
b. Ms↑ or P↓ or Y↓ in the US, or Ee↑ or some combination of these changes occurs.
c. Ms↓ or P↑ or Y↑ in either the US or in Europe, or Ee↑ or some combination of these changes occurs.
d. None of the above.
In the first column of the table below, please list all the three main variables that affect the quantity of
money demanded (Md). (Please specify the symbols that represent the variable plus the descriptive
name of the variable; for example: “E, the price of the foreign currency in units of the domestic
currency.”) In the second column, specify whether Md increases or decreases when the variable you
listed in the first column increases.
When this variable increases …
Md …
In the second column of the Table below, indicate whether a permanent increase in Ms, the quantity of
money circulating in the economy, will lead to an increase (↑), a decrease (↓), an ambiguous change
(?), or no change (0) in the variables listed in the first column in the long run. In the third column of the
attached table, indicate whether a permanent increase in the growth rate of Ms will lead to an increase,
a decrease, an ambiguous change, or no change in the variables listed in the first column in the long
run.
Long run effect of an increase in …
Money supply
Growth rate of money supply
π, the inflation rate
E
Assume floating (flexible) exchange rates. When doing the second column, assume that growth of
money supply is unchanged at the time the money supply increases. And when doing the third column,
assume that the money supply is unchanged at the time its growth rate increases. This is further clarified
in the diagram below.
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Column 2
Column 3
Ms
Ms
Time
Time
Chapter 16 Price Levels and the Exchange Rate in the Long Run
1. Which of the following statements is the most accurate? The law of one price states:
(a) In competitive markets free of transportation costs and official barrier to trade, identical
goods sold in different countries must sell for the same price when their prices are expressed
in terms of the same currency.
(b) In competitive markets free of transportation costs and official barrier to trade, identical
goods sold in the same country must sell for the same price when their prices are expressed in
terms of the same currency.
(c) In competitive markets free of transportation costs and official barrier to trade, identical
goods sold in different countries must sell for the same price.
(d) Identical goods sold in different countries must sell for the same price when their prices are
expressed in terms of the same currency.
(e) None of the above
Answer: A
2. Under Purchasing Power Parity,
(a) E$/E = PUS/PE
(b) E$/E = PE/PES
(c) E$/E = PUS + PE
(d) E$/E = PUS – PE
(e) None of the above.
Answer: A
3. Which of the following statements is the most accurate? In general, under the monetary
approach to the exchange rate,
(a) While the short -run interest rate does not depend on the absolute level of the money supply,
continuing growth in the money supply eventually will affect the interest rate.
(b) While the long-run interest rate does depend on the absolute level of the money supply,
continuing growth in the money supply do not affect the interest rate.
(c) While the long-run interest rate does not depend on the absolute level of the money supply,
continuing growth in the money supply eventually will affect the interest rate.
(d) The long-run interest rate does not depend on the absolute level of the money supply, and
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thus continuing growth in the money supply will not affect the interest rate.
(d) None of the above statement is true.
Answer: C
4. If people expect relative PPP to hold,
(a) The difference between the interest rates offered by dollar and euro deposits will equal the
difference between the inflation rates expected, in the United States and Europe, over the
relevant horizon.
(b) The difference between the interest rates offered by dollar and euro deposits will equal the
difference between the inflation rates expected in Europe and the United States.
(c) The difference between the interest rates offered by dollar and euro deposits will equal the
difference between the inflation rates expected, over the relevant horizon, in the United
States and Europe, in the short run.
(d) The difference between the interest rates offered by dollar and euro deposits will be above
the difference between the inflation rates expected, over the relevant horizon, in the United
States and Europe.
(e) None of the above statements is true.
Answer: A
5. Under PPP (and the Fisher Effect),
(a) A rise in a country’s expected inflation rate will eventually cause a more-than proportional
rise in the interest rate that deposits in its currency earn, in order to accommodate for the
higher inflation.
(b) A fall in a country’s expected inflation rate will eventually cause an equal rise in the interest
rate that deposits in its currency earn.
(c) A rise in a country’s expected inflation rate will eventually cause an equal rise in the interest
rate that deposits in its currency earn.
(d) A rise in a country’s expected inflation rate will eventually cause a less than proportional rise
in the interest rate that deposits in its currency earn, in order to accommodate the rise in
expected inflation.
(e) None of the above statement is true.
Answer: C
6. Which of the following statements is the most accurate?
(a) The law of one price does fare well in all recent studies.
(b) The law of one price does fare well in many recent studies.
(c) The law of one price sometimes fares well in recent studies.
(d) The law of one price does not fare well in recent studies.
(e) None of the above statements is true.
Answer: D
7. An increase in the world relative demand for U.S. output causes
(a) a short-run real depreciation of the dollar against the euro
(b) a long-run real appreciation of the dollar against the euro
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(c) a long-run real depreciation of the dollar against the euro
(d) (a) and (b) only
(e) None of the above
Answer: B
8. Which of the following statements is most accurate?
(a) A relative expansion of U.S. output causes a long-run depreciation of the dollar against the
euro, while a relative expansion of European output causes a long-run real appreciation of the
dollar against the euro
(b) A relative decline of U.S. output causes a long-run depreciation of the dollar against the euro,
while a relative expansion of European output causes a long-run real appreciation of the
dollar against the euro
(c) A relative expansion of U.S. output causes a long-run appreciation of the dollar against the
euro, while a relative expansion of European output causes a long-run real depreciation of the
dollar against the euro
(d) A relative expansion of U.S. output causes a long-run depreciation of the dollar against the
euro, while a relative decline of European output causes a long-run real appreciation of the
dollar against the euro
(e) A relative decline of U.S. output causes a long-run depreciation of the dollar against the euro,
while a relative decline of European output causes a long-run real appreciation of the dollar
against the euro
Answer: A
9. When all variables start out at their long-run levels, the most important determinant of long-run
swings is nominal exchange rates is
(a) a shift in relative money supply levels
(b) a shift in relative money supply growth rates
(c) a change in relative output demand
(d) a change in relative output supply
(e) All of the above
Answer: E
10. Which of the following statements is most accurate?
(a) In the output market, an increase in demand for U.S. output leads to an increase in the longrun nominal dollar/euro exchange rate
(b) In the output market, an increase in the demand for European output leads to an increase in
the long-run nominal dollar/euro exchange rate
(c) In the output market, a decrease in demand for U.S. output leads to a decrease in the longrun nominal dollar/euro exchange rate
(d) In the output market, a decrease in the demand for European output leads to a decrease in
the long-run nominal dollar/euro exchange rate
(e) None of the above
Answer: B
11. Which of the following statements is most accurate?
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(a) In the money market, an increase in U.S. money supply level leads to a proportional increase
in the long-run nominal dollar/euro exchange rate
(b) In the money market, an increase in European money supply level leads to a proportional
increase in the long-run nominal dollar/euro exchange rate
(c) In the money market, an increase in U.S. money supply growth rate leads to a decrease in the
long-run nominal dollar/euro exchange rate
(d) In the money market, an increase in European money supply growth leads to an increase in
the long-run nominal dollar/euro exchange rate
(e) In the money market, an increase in U.S. money supply level leads to a proportional decrease
in the long-run nominal dollar/euro exchange rate
Answer: A
12. The expected real interest rate (re) in terms of the nominal interest rate (R) and the expected
inflation rate (e) is given by
(a) re = e + R
(b) re = 2e + R2
(c) re = e + R2
(d) re = R − e
(e) re = R2 − e
Answer: D
13. The real value of the foreign currency, q, is the amount of domestic goods that can be traded for
one unit of foreign goods. Then
a.
b.
c.
d.
q = E × P/P*.
q = E × P*/P.
q = M/P × L(R, Y).
q = P × L(R, Y)/M.
14. An increase in the world’s relative demand for U.S. output causes
a.
b.
c.
d.
a long-run real appreciation of the dollar against the Euro (q↓)
a long-run real depreciation of the dollar against the Euro (q↑)
No change in q.
None of the above
15. Which of the following statements is most accurate?
a. An increase in U.S. output relative to European output (YUS/YE↑) causes a long-run depreciation
of the dollar against the euro (q↑), while a relative increase of European output (YUS/YE↓)
causes a long-run real appreciation of the dollar against the euro (q↓).
b. A relative decrease of U.S. output causes a long-run depreciation of the dollar against the euro,
while a relative increase of European output causes a long-run real appreciation of the dollar
against the euro
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c. A relative increase of U.S. output causes a long-run appreciation of the dollar against the euro,
while a relative increase of European output causes a long-run real depreciation of the dollar
against the euro
d. A relative increase of U.S. output causes a long-run depreciation of the dollar against the euro,
while a relative decrease of European output causes a long-run real appreciation of the dollar
against the euro
e. A relative decrease of U.S. output causes a long-run depreciation of the dollar against the euro,
while a relative decrease of European output causes a long-run real appreciation of the dollar
against the euro
16. Betty says, “If over the next year US inflation is expected to be 10% and Europe’s inflation is
expected to be 3%, then people probably expect the dollar price of a Euro to increase by 7%.”
Betty’s claim will be true if the behavior of the economy is accurately described by
a.
b.
c.
d.
Relative Purchasing Power Parity
Interest Parity
Real Interest Parity
None of the above; Betty is making a mistake.
17. Betty says, “If the price of a Big Mac sandwich is $4.00 in the US and €2.00 in France, then it
must be that one Euro is worth two dollars (i.e., E = 2.00).” Betty’s claim will be true if the
behavior of currency markets is accurately described by
a.
b.
c.
d.
e.
Absolute Purchasing Power Parity
Relative Purchasing Power Parity
Interest Parity
Real Interest Parity
None of the above; Betty is making a mistake.
Chapter 17 Output and the Exchange Rate in the Short Run
1. Revisiting the discussion in Chapter 14 of interest parity (or, equilibrium in the foreign currency
market), the value of the foreign currency (E) increases when _______.
a.
b.
c.
d.
e.
R decreases.
R* increases.
Ee increases.
All of the above.
None of the above.
2. Revisiting the discussion in Chapter 15 of equilibrium in the money market, the domestic interest rate
(R) increases when _______.
a.
b.
c.
d.
M/P decreases
Y increases
All of the above
M/P increases
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e. Y decreases
3. Combining the issues discussed in the last two questions, simultaneous equilibrium in both the
currency market and the money market implies that E increases when _______.
a.
b.
c.
d.
e.
M/P increases and/or M*/P* decreases.
Y decreases and/or Y* increases.
Ee increases.
All of the above.
None of the above.
4. Under sticky prices,
(a) A fall in the money supply raises the interest rate in order to preserve money market
equilibrium.
(b) A fall in the money supply reduces the interest rate to preserve money market equilibrium.
(c) A fall in the money supply keeps the interest rate intact to preserve money market
equilibrium.
(d) A fall in the money supply does not affect the interest rate in the short run, only in the long
run.
(e) None of the above statements is true.
Answer: A
5. Under sticky prices,
(a) An interest rate rise is associated with lower expected deflation and a long-run currency
appreciation, so the currency appreciates immediately.
(b) An interest rate rise is associated with higher expected inflation and a long-run currency
appreciation, so the currency appreciates immediately.
(c) An interest rate rise is associated with lower expected inflation and a long-run currency
depreciation, so the currency appreciates immediately.
(d) An interest rate rise is associated with lower expected inflation and a long-run currency
depreciation, so the currency depreciates immediately.
(e) An interest rate rise is associated with lower expected inflation and a long-run currency
appreciation, so the currency appreciates immediately.
Answer: E
6. How does an increase in the real exchange rate affect exports and imports?
(a) Exports increase; imports decrease.
(b) Exports decrease; imports increase.
(c) Exports increase; imports change ambiguously.
(d) Exports change ambiguously; imports decrease.
(e) Exports increase; imports are constant.
Answer: C
7. How does a rise in real income affect aggregate demand?
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(a) Y Im CA AD , but Y  C  AD  by more
(b) Y Im CA AD , but Y  C  AD  by more
(c) Y Im CA AD , and Y  C  AD 
(d) Y Im CA AD , but Y  C  AD  by less
(e) Y Im CA AD , but Y  C  AD  by less
Answer: A
8. If the economy starts in long-run equilibrium, a permanent fiscal expansion will cause
(a) An increase in exchange rate, E
(b) A decrease in exchange rate, E
(c) An increase in long-run output, Y
(d) A decrease in long-run output, Y
(e) Shifting of the AA curve up and to the right
Answer: B
9. Which of the following is true?
(a) Monetary expansion increases the current account balance (CA).
(b) Monetary expansion decreases the current account balance.
(c) Fiscal expansion increases the current account balance.
(d) Fiscal expansion decreases the current account balance.
(e) Both (a) and (d)
Answer: E
10. In the short run, with prices fixed, how would an increase in government spending affect the DD-AA
schedules?
(a) It will increase output and appreciate the currency.
(b) It will increase output and depreciate the currency.
(c) It will decrease output and appreciate the currency.
(d) It will decrease output and depreciate the currency.
(e) None of the above.
Answer: A
11. Which one of the following statements is the most accurate?
(a) An increase in disposable income improves the current account.
(b) An increase in disposable income does not affect the current account.
(c) An increase in disposable income worsens the current account.
(d) An increase in income worsens the current account.
(e) An increase in income improves the current account.
Answer: C
12. In the short-run, any rise in P*/P will cause
(a) An upward shift in the aggregate demand function and a reduction in output
(b) An upward shift in the aggregate demand function and an expansion of output
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(c) A downward shift in the aggregate demand function and an expansion of output
(d) An downward shift in the aggregate demand function and a reduction in output
(e) An upward shift in the aggregate demand function but leaves output intact
Answer: B
13. In the short-run, a temporary increase in the money supply
(a) Shifts the AA curve to the right, increases output and depreciates the currency
(b) Shifts the AA curve to the left, increases output and depreciates the currency
(c) Shifts the AA curve to the left, decreases output and depreciates the currency
(d) Shifts the AA curve to the left, increases output and appreciates the currency
(e) Shifts the AA curve to the right, increases output and appreciates the currency
Answer: A
14. In the short-run, expansionary fiscal policy causes
(a) A shift of the DD curve to the left, output increases and the currency appreciates
(b) A shift of the DD curve to the right, output decreases and the currency appreciates
(c) A shift of the DD curve to the right, output increases and the currency depreciates
(d) A shift of the DD curve to the left, output decreases and the currency depreciates
(e) A shift of the DD curve to the right, output increases and the currency appreciates
Answer: E
15. The DD schedule shows all combinations of which two variables so that the output market is in
equilibrium?
(a) Imports and exports.
(b) Exports and the exchange rate.
(c) Foreign prices and the exchange rate.
(d) Output and the exchange rate.
(e) Output and exports.
Answer: D
16. How is the AA schedule derived?
(a) It is derived by the schedule of interest rate and output combinations that are consistent with
equilibrium in the domestic money market and the foreign exchange market.
(b) It is derived by the schedule of exchange rate and output combinations that are consistent
with equilibrium in the foreign money market and the domestic exchange market.
(c) It is derived by the schedule of exchange rate and output combinations that are consistent
with equilibrium in the domestic money market and the foreign exchange market.
(d) It is derived by the schedule of exchange rate and output combinations that are consistent
with equilibrium in the domestic bond market and the foreign asset market.
(e) None of the above.
Answer: C
17. Let the total desired consumption spending of households be denoted C. According to the
theory discussed in class, C _____ when Y increases, _______ when T increases, and ______
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when R increases. Fill in the blanks using any or all of the following answers: increases,
decreases, stays unchanged. Here T represents the government’s net tax revenue.
18. In the first column of the table below, please list three variables that affect net exports (NX or
CA). (Please specify the symbols that represent the variable plus the descriptive name of the
variable; for example: “P*, the foreign price level.”) In the second column, specify whether NX
increases or decreases when the variable you listed in the first column increases.
When this variable increases …
NX…
19. The goods market is in equilibrium when
a. Y = C + I + G + exports
b. Y = C + I + G + exports – imports
c. Y = C + I + G + exports + imports
d. Ms = L(R) × P × Y.
Chapter 18 Fixed Exchange Rates and Foreign Exchange Intervention
1.
Suppose the government of Country X—specifically, its central bank—decides to fix the exchange
rate of its currency with respect to the currency of Country Y. Suppose the exchange value of
Country X’s currency would rise in the absence of intervention by its central bank. What would the
central bank of Country X have to do to keep the exchange rate fixed?
a. Print additional amounts of the domestic currency and buy Country Y’s currency on the foreign
exchange market. This will increase the domestic money supply (Ms) as well as the domestic
stock of foreign currency.
b. Use its reserves of Country Y’s currency to buy the domestic currency on the foreign exchange
market. This will reduce the domestic money supply as well as the domestic reserves of foreign
currency.
c. Print additional amounts of the domestic currency and buy Country Y’s currency on the foreign
exchange market. This will increase the domestic money supply and reduce the domestic
reserves of foreign currency.
d. Use its stock of Country Y’s currency to buy the domestic currency on the foreign exchange
market. This will increase the domestic money supply in Country X as well as the domestic
reserves of foreign currency.
2.
Under fixed exchange rates, the expected rate of appreciation of the foreign currency is zero.
Therefore, interest parity implies that
a.
b.
c.
d.
the foreign interest rate equals the domestic interest rate
the foreign interest rate equals the domestic interest rate plus the domestic inflation rate
the foreign interest rate is less than the domestic interest rate
the foreign interest rate is unrelated to the domestic interest rate
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3.
By fixing the exchange rate, the central bank gives up its ability to
(a) adjust taxes
(b) increase government spending
(c) influence the economy through fiscal policy
(d) depreciate the domestic currency
(e) influence the economy through monetary policy
Answer: E
4.
When a country’s currency is devalued:
(a) Output decreases.
(b) Output increases.
(c) The money supply decreases.
(d) The money supply increases.
(e) both (b) and (d)
Answer: E
5.
Which one of the following statements is most true?
(a) Any central bank purchase of assets automatically results in an increase in the domestic
money supply, while any central bank sale of assets automatically causes the money supply to
decline.
(b) Any central bank purchase of assets results in an increase in the domestic money supply,
while any central bank sale of assets causes the money supply to decline.
(c) Any central bank purchase of assets automatically results in a decrease in the domestic
money supply, while any central bank sale of assets automatically causes the money supply to
decline.
(d) Any central bank purchase of assets automatically results in a decrease in the domestic
money supply, while any central bank sale of assets automatically causes the money supply to
increase.
(e) None of the above statement is true.
Answer: A
6.
Under a fixed exchange rate system, the following condition should hold for domestic money
market equilibrium:
(a) Ms/P = L(R*, Y).
(b) Ms/P = L(R, Y).
(c) Md/P = L(R*, Y).
(d) Ms = L(R*, Y).
(e) P = L(R*, Y).
Answer: A
7.
Which one of the following statements is the most accurate?
(a) Fiscal policy has the same effect on output under fixed and flexible exchange rate regimes.
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(b) Fiscal policy affects output more under fixed than under flexible exchange rate regimes.
(c) Fiscal policy affects output less under fixed than under flexible exchange rate regimes.
(d) Fiscal policy cannot affect output under fixed exchange rate but does affect output under
flexible exchange rate regimes.
(e) None of the above statements are true.
Answer: B
8.
Which one of the following statements is the most accurate?
(a) A devaluation occurs when the central bank lowers the domestic currency price of foreign
currency, E, and a revaluation occurs when the central bank raises E.
(b) A devaluation occurs when the central bank raises the domestic currency price of foreign
currency, E, and a revaluation occurs when the central bank lowers E.
(c) Devaluation occurs when the domestic currency price of foreign currency, E, raises and a
revaluation occurs when E is lowered.
(d) A devaluation occurs when the central bank of the foreign country raises the domestic
currency price of foreign currency, E, and a revaluation occurs when the central bank of the
foreign country lowers E.
(e) None of the above statements is true.
Answer: B
9.
Under fixed exchange rate, which one of the following statements is the most accurate?
(a) Devaluation causes a decrease in output, a decrease in official reserves, and a contraction of
the money supply.
(b) Devaluation causes a rise in output, a rise in official reserves, and an expansion of the money
supply.
(c) Devaluation causes a rise in output and a rise in official reserves.
(d) Devaluation causes a rise in output and an expansion of the money supply.
(e) Devaluation causes a rise in official reserves, and an expansion of the money supply.
Answer: B
10.
Under fixed exchange rate, which one of the following statements is the most accurate?
(a) Devaluation causes a reduction of the money supply.
(b) Devaluation has no effect on the stock of money.
(c) Devaluation causes an expansion of the money supply.
(d) Devaluation causes a reduction in output.
(e) Devaluation causes a reduction in official reserves.
Answer: C
Miscellaneous
1.
Absolute Purchasing Power Parity is the assumption that
a. The domestic price level (P) is equal to the foreign price level (P*) once foreign prices are
multiplied by the value of the foreign currency in units of the domestic currency (E) in order to
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express all prices in the same currency. Therefore, P = E × P*. This also implies that the real
exchange rate is q = 1.
b. The real exchange rate is constant, though not necessarily equal to 1.
c. The domestic price level (P) is equal to the foreign price level (P*) once foreign prices are
multiplied by the value of the foreign currency in units of the domestic currency (E) in order to
express all prices in the same currency. Therefore, the real exchange rate is constant, though
not necessarily equal to 1.
d. The domestic interest rate (R) is equal to the foreign interest rate (R*) plus the expected rate of
appreciation of the foreign currency.
2.
Relative Purchasing Power Parity is the assumption that
a. The domestic price level (P) is equal to the foreign price level (P*) once foreign prices are
multiplied by the value of the foreign currency in units of the domestic currency (E) in order to
express all prices in the same currency. Therefore, P = E × P*. This also implies that the real
exchange rate is q = 1.
b. The real exchange rate is constant, though not necessarily equal to 1.
c. The domestic price level (P) is equal to the foreign price level (P*) once foreign prices are
multiplied by the value of the foreign currency in units of the domestic currency (E) in order to
express all prices in the same currency. Therefore, the real exchange rate is constant, though
not necessarily equal to 1.
d. The domestic interest rate (R) is equal to the foreign interest rate (R*) plus the expected rate of
appreciation of the foreign currency.
3.
Under relative purchasing power parity,
a. The expected rate of appreciation of the foreign currency is equal to the excess of the foreign
inflation rate over the domestic inflation rate
b. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency’s
value is expected to appreciate by 2%
c. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency’s
value is expected to depreciate by 2%
d. If the foreign interest rate is 7% and the domestic interest rate is 5%, the foreign currency’s
value is expected to depreciate by 2%
4.
Under uncovered interest rate parity,
a. The expected rate of appreciation of the foreign currency is equal to the excess of the foreign
inflation rate over the domestic inflation rate
b. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency’s
value is expected to appreciate by 2%
c. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency’s
value is expected to depreciate by 2%
d. If the foreign interest rate is 7% and the domestic interest rate is 5%, the foreign currency’s
value is expected to depreciate by 2%
5.
Under relative purchasing power parity and fixed exchange rates, the expected rate of
appreciation of the foreign currency is zero. Therefore,
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a.
b.
c.
d.
6.
the foreign inflation rate equals the domestic inflation rate
the foreign inflation rate equals the domestic inflation rate plus the domestic interest rate
the foreign inflation rate is less than the domestic inflation rate
the foreign inflation rate is unrelated to the domestic inflation rate
Tariffs, which are taxes on imported goods and services, can raise output (Y) and net exports (NX)
a. in both the long run and the short run, under fixed exchange rates but not under flexible
exchange rates
b. in neither the long run nor the short run
c. in the short run but not in the long run, and under fixed exchange rates but not under flexible
exchange rates
d. in the long run but not in the short run
e. in the short run but not in the long run, and under both flexible and fixed exchange rates
7.
A country can improve its net exports (NX)
a. by implementing contractionary fiscal policy (G↓ and/ or T↑). This is effective in the short run
and in the long run, under fixed exchange rates and under flexible exchange rates.
b. by implementing expansionary fiscal policy (G↑ and/ or T↓). This is effective in the short run
and in the long run, under fixed exchange rates and under flexible exchange rates.
c. by implementing contractionary fiscal policy (G↓ and/ or T↑). This is effective only in the short
run and only under flexible exchange rates.
d. by implementing expansionary fiscal policy (G↑ and/ or T↓). This is effective only in the short
run and only under flexible exchange rates.
e. by implementing contractionary fiscal policy (G↓ and/ or T↑). This is effective only in the short
run and only under fixed exchange rates.
8.
Expansionary monetary policy, which consists of an increase in money supply (M↑) under flexible
exchange rates and devaluation (E↑) under fixed exchange rates, affects output (Y) and net
exports (NX) in the short run as follows:
a.
b.
c.
d.
9.
Irrespective of the exchange rate system, expansionary fiscal policy (G↑ and/ or T↓) will cause
output to increase (Y↑)
a.
b.
c.
d.
10.
Y↑ and NX↑
Y↑ and NX↓
Y↓ and NX↓
Y↓ and NX↑
In the long run, but not in the short run
In both the long run and the short run
In neither the long run nor the short run
In the short run, but not in the long run
Expansionary monetary policy (M↑ under flexible exchange rates and E↑ under fixed exchange
rates) will cause output to increase (Y↑)
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a.
b.
c.
d.
In the long run, but not in the short run
In both the long run and the short run
In neither the long run nor the short run
In the short run, but not in the long run
Chapter 20 Optimum Currency Areas and the European Experience
1. If each of the 50 states of the United States of America had its own central bank and its own
currency, then each state would be ___ able to cope with asymmetric shocks, and the extent of
trade between the states would ____.
a.
b.
c.
d.
better; increase
less; increase
less; decrease
better; decrease
2. On January 1, 1999
a. Eleven European countries gave up their currencies and jointly adopted a single currency, the
Euro.
b. The Bretton Woods system of fixed exchange rates came to an end.
c. A massive currency crisis, which eventually engulfed many countries in Asia, began in Thailand.
d. The U.S. Treasury Department extended a $20 billion loan to Mexico to rescue it from a
developing currency crisis.
3. Any collection of regions that use the same currency—such as the towns of Nassau County, the
counties of New York state, the states of the USA, etc.—faces the problem of asymmetric
shocks. This problem can be described as follows: When some regions have high unemployment
and therefore require _____ in the quantity of money and other regions have high inflation and
therefore require ______ in the quantity of money, the authorities that control the quantity of
money would find it impossible to satisfy every region.
a.
b.
c.
d.
increase; increase
increase; decrease
decrease; decrease
decrease; decrease
4. The problem of asymmetric shocks will be less painful for the European Monetary Union if
a. The economies of the EMU are so closely tied together through trade that their business cycles
are largely synchronized (i.e., when one country has high unemployment so do the others and
when one country has high inflation so do the others).
b. It is easy for workers to move from country to country within the EMU in search of a job.
c. There exists a system of fiscal transfers that use temporarily high tax revenues of one member
country to aid those member countries with temporarily low tax revenues.
d. All of the above.
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e. None of the above.
5. In theory, there is no difference between (i) a group of countries that have their own separate
currencies but maintain fixed exchange rates between those currencies and (ii) a group of
countries that adopt a single currency. Y et it made sense for twelve European countries to form
a monetary union because
a. System (i) is vulnerable to currency crises, especially when there are no restrictions on capital
flows, whereas system (ii) is not.
b. The single currency was intended as “a potent symbol of Europe’s desire to place cooperation
ahead of the national rivalries that often had led to war in the past”.
c. In a system of fixed exchange rates, the “fixed” rates could be—and often were—changed.
Therefore, system (i) would always carry some exchange rate uncertainty, whereas a monetary
union with a single currency would not.
d. All of the above.
e. None of the above.
6. The countries that belong to the EMU must abide by the Stability and Growth Pact (SGP) of
1997. This requires each country to keep its public-sector budget deficit under 3 percent of its
GDP and its public-sector debt under 60 percent of its GDP.
a. This restriction on a member nation’s ability to use fiscal policy to stabilize its economy is not a
big deal because monetary policy can be used by each country for that purpose.
b. This restriction on a member nation’s ability to use fiscal policy to stabilize its economy is
potentially significant because nations that are in a monetary union do not have the ability to
conduct their own monetary policy.
c. The SGP makes it easier for EMU nations to cope with the problem of asymmetric shocks.
d. The SGP makes the actual occurrence of asymmetric shocks more likely.
7. According to the theory of optimum currency areas, a monetary union (or, equivalently, a
system of fixed exchange rates) is most appropriate between places that
a. Are closely integrated through international trade and factor movements.
b. Have weak or non-existent economic links, so that events in one country would have little or no
effect on the other countries to which its currency is fixed.
c. Have close political links.
d. Aspire to peaceful relations but have a long history of mutual hostility.
8. According to this course’s textbook,
a. Europe (i.e., the area under EMU) is an optimum currency area.
b. Europe is not an optimum currency area.
c. Europe is not an optimum currency area but will become one when it expands to include several
countries in East Europe and, possibly, Turkey.
d. None of the above.
9. What are the biggest advantages the U.S. has above the EU in terms of being an Optimum
Currency Area?
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(a) Low mobility of labor, higher labor productivity, lower level of intra-regional trade
(b) High unionization of U.S. Labor force
(c) I don’t know
(d) High mobility of labor force, more transfer payments between regions
(e) Higher uniformity of population’s taste in consumption
Answer: D
10. The birth of the Euro
(a) resulted in fixed exchange rates between all EMU member countries.
(b) resulted in flexible exchange rates between all EMU member countries.
(c) resulted in crawling-peg exchange rates between all EMU member countries.
(d) resulted in non-currency board exchange rates between all EMU member countries.
(e) None of the above.
Answer: A
11. Which of the following is true?
(a) All European countries are part of the EMU
(b) All Western European countries are part of the EMU
(c) Originally, 11 countries joined the EMU on January 1999
(d) Not all Western European countries are part of the EMU
(e) None of the above.
Answer: C
12. The EU countries were prompted to seek closer coordination of monetary policies and greater
exchange rate stability in order to
(a) to enhance Europe’s role in the world monetary system
(b) to turn the European Union into a truly unified market
(c) both to enhance Europe’s role in the world monetary system and to turn the European Union
into a truly unified market
(d) None of the above.
(e) both to turn the European Union into a truly unified market and to counter the rise of Japan in
international financial markets
Answer: C
13. To join the EMU, a country must have
(a) a public-sector deficit no higher than 3 percent of its GDP in general.
(b) a public-sector deficit no higher than 2 percent of its GDP in general.
(c) a public-sector deficit no higher than 1 percent of its GDP in general.
(d) a zero public-sector deficit.
(e) None of the above.
Answer: A
14. To join the EMU, a country must have a public debt below or approaching a reference level of
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(a) 50 percent of its GDP.
(b) 10 percent of its GDP.
(c) 60 percent of its GDP.
(d) 100 percent of its GDP.
(e) 5 percent of its GDP.
Answer: C
15. The efficiency
(a) gain from a fixed exchange rate with the euro is smaller when trade between say, Norway and
the euro zone, is extensive than when it is small.
(b) gain from a fixed exchange rate with euro is greater when trade between say, Norway and the
euro zone, is extensive than when it is small.
(c) loss from a fixed exchange rate with the euro is smaller when trade between say, Norway and
the euro zone, is extensive than when it is small.
(d) gain from a fixed exchange rate with euro is the same as when trade between say, Norway
and the euro zone, is extensive than when it is small.
(e) gain from a fixed exchange rate with euro is the same as when trade between say, Norway
and the euro zone, is small than when it is small.
Answer: B
16. Which one of the following statements is true?
(a) The less extensive are cross-border trade and factor movements, the greater is the gain from
a fixed cross-border exchange rate.
(b) The more extensive are cross-border trade and factor movements, the greater is the loss from
a fixed cross-border exchange rate.
(c) The more extensive are cross-border trade and factor movements, the greater is the gain
from a fixed cross-border exchange rate.
(d) The more extensive are cross-border trade, the greater is the loss from a fixed cross-border
exchange rate.
(e) The more extensive are factor movements, the greater is the loss from a fixed cross-border
exchange rate.
Answer: C
17. A country that joins an exchange rate area
(a) gives up its ability to use the exchange rate for the purpose of stabilizing output and
employment.
(b) does not give up its ability to use the exchange rate and monetary policy for the purpose of
stabilizing output and employment.
(c) gives up its ability to use the exchange rate and monetary policy for the purpose of stabilizing
output and employment.
(d) gives up its ability to use only monetary policy for the purpose of stabilizing output and
employment.
(e) does not gives up its ability to use only monetary policy for the purpose of stabilizing output
and employment.
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Answer: C
18. Which one of the following statements is true?
(a) A fixed exchange rate automatically cushions the economy’s output and employment by
allowing an immediate change in the relative price of domestic and foreign goods.
(b) A flexible exchange rate does not automatically cushions the economy’s output and employment
by allowing an immediate change in the relative price of domestic and foreign goods.
(c) A flexible exchange rate automatically cushions the economy’s output and employment by
allowing an immediate change in the relative price of domestic and foreign goods.
(d) A flexible exchange rate automatically cushions the economy’s output and employment by
allowing an immediate change in the absolute price of domestic and foreign goods
(e) None of the above.
Answer: C
19. Since Norway has close trading links with the euro zone,
(a) a small reduction in its price will lead to an increase in euro zone demand for Norwegian
goods that is large relative to Norway’s output. Thus, full employment can be restored fairly
quickly.
(b) a small reduction in its price will lead to a decrease in euro zone demand for Norwegian goods
that is large relative to Norway’s output. Thus, full employment can be restored fairly quickly.
(c) a small reduction in its price will lead to an increase in euro zone demand for Norwegian
goods that is small relative to Norway’s output. Thus, full employment can be restored fairly
quickly.
(d) a big reduction in its price will lead to an increase in euro zone demand for Norwegian goods
that is large relative to Norway’s output. Thus, full employment can be restored fairly quickly.
(e) None of the above.
Answer: A
20. The level of fiscal federalism in the European Union is
(a) too big to cushion member countries from adverse economic events
(b) too small to cushion member countries from adverse economic events
(c) appropriate to cushion member countries from adverse economic events
(d) too big relative to the one in the U.S.
(e) similar in its level to that of the U.S.
Answer: B
21. A key barrier to labor mobility within Europe is
(a) full employment in most European countries
(b) differences in language and culture
(c) lack of transportation
(d) None of the above
Answer: B
22. Fiscal federalism in the EU refers to
25
(a) one nation’s control of the monetary policy of all the other nations
(b) freedom of member countries to leave the EU at any time
(c) the transfer of economic resources from members with healthy economies to those suffering
economic setbacks
(d) one nation’s freedom to abandon the Euro and use its own currency
(e) None of the above
Answer: C
23. Which of the following is true about the future of the EU and its associated institutions?
(a) the lack of a strong EU political center may limit the ECB’s political legitimacy in the eyes of
the European public
(b) there is a danger that voters throughout Europe will come to view the ECB as a distant and
politically unaccountable group of technocrats unresponsive to people’s needs
(c) Asymmetric economic development within different countries of the euro zone will be hard to
handle through monetary policy
(d) persistent barriers to labor mobility might continue to result in high levels of unemployment
(e) All of the above
Answer: E
24. The theory of optimum currency areas predicts that
(a) floating exchange rates are most appropriate for areas closely integrated through
international trade and factor movements
(b) fixed exchange rates are most appropriate for areas that are loosely integrated through
international trade and factor movements
(c) fixed exchange rates are most appropriate for areas closely integrated through international
trade and factor movements
(d) floating exchange rates are most appropriate for all countries in Europe
(e) fixed exchange rates are most appropriate for all countries in Europe
Answer: C
December 18, 2011
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