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Question 1

The European Economic and Monetary Union
A) set up a single currency and sole bank for European economic monetary policy.
B) eliminated all barriers to trade such as tax differentials between borders.
C) produced a single government for handling European affairs.
D) created the Common Agricultural Pact.
E) eliminated all local currencies in Western Europe.

Answer 1

A)

Question 2

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) resulted in floating exchange rates between all EMU member countries.

Answer 2

A

Question 3

The EU countries were prompted to seek closer coordination of monetary policies and greater exchange rate stability in order
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) both to turn the European Union into a truly unified market and to counter the rise of Japan in international financial markets.
E) to homogenize all European cultures.

Answer 3

C

Question 4

Under the EMS, Germany set the system’s
A) monetary policy while the other European countries pegged their currencies to the DM.
B) fiscal policy while the other European countries pegged their currencies to the DM.
C) monetary policy while the other European countries kept their currencies fluctuating relative to the DM.
D) fiscal policy while the other European countries kept their currencies fluctuating relative to the DM.
E) monetary policy, while other European countries maintained their traditional policies.

Answer 4

A

Question 5

An inflation-prone country
A) gains from vesting its monetary policy decisions with a “conservative” central bank.
B) loses from vesting its monetary policy decisions with a “conservative” central bank.
C) gains from vesting its fiscal policy decisions with a “conservative” central bank.
D) loses from vesting its fiscal policy decisions with a “conservative” central bank.
E) remains constant when vesting its fiscal policy decisions with a “conservative” central bank.

Answer 5

A

Question 6

The 1991 Maastricht Treaty can be best described as
A) a peace treaty between Europe and the United States.
B) an agreement for the accession of the Netherlands into the EU.
C) an agreement for the creation of a free trade area.
D) a provision for the introduction of a single European currency and European central bank.
E) the beginning of a floating exchange rate European monetary system.

Answer 6

D

Question 7

During the period from 1978-2012, the difference between annual inflation rates of EU countries and the German inflation rate
A) grew at an accelerating rate.
B) remained fairly constant.
C) largely disappeared.
D) went through periods of hyperinflation.
E) trended upward at a declining rate.

Answer 7

C

Question 8

The German central bank in the European Monetary System, 1979-1998
A) was very inflation-averse.
B) was moderately inflation-averse.
C) was willing to accept inflation.
D) lacked control over inflation since it had fixed its exchange rate.
E) lacked sufficient reserves.

Answer 8

A

Question 9

The result of the reunification of eastern and western Germany in 1990
A) was a boom in Germany and higher inflation, with no effect on nearby countries.
B) was a recession in Germany and lower inflation, with no effect on nearby countries.
C) was a boom in Germany and higher inflation, and, with other EMS countries’ commitment to fixed exchange rates, a deep recession in nearby countries.
D) was a recession in Germany and lower inflation, and, with other EMS countries’ commitment to fixed exchange rates, a deep recession in nearby countries.
E) was a recession in Germany and lower inflation, causing a boom in nearby countries.

Answer 9

C

Question 10

The credibility theory of EMS had as an effect
A) the inflation rates of member countries converging to the low German levels, a result that was not matched by similar countries who did not fix their exchange rates.
B) the inflation rates of member countries failing to converge to the low German levels.
C) the inflation rates of member countries converging to the low German levels, but other countries including U.S. and Britain also reduced inflation in this time period without fixing exchange rates.
D) the inflation rate in Germany rose to match the inflation rates of other

Answer 10

C

Question 11

How and why did Europe set up its single currency?

Answer 11

The why part is because large fluctuations in the exchange rates among the European countries disturbed trade. Also, one of the main reasons was to design a way to prevent future world war. The how part of the question is related to the collapse of Bretton Woods and the European Currency reform of 1969-1978. The Werner Report of 1971 establishes three-phase program to lead to the EMU.

Question 12

Discuss the effects of the reunification of eastern and western Germany in 1990 on both Germany and its neighboring European countries.

Answer 12

Germany: boom, high interest rates to fight inflation. Other European countries: France, Italy and UK in recession, trying to match the high German interest rates to hold their currencies fixed against Germany’s, thereby pushing their economies into deep recession. Other European countries tried to continue the fixed exchange rate in order not to lose the credibility they had build up since 1985. The policy conflict between Germany and the other European countries led to a series of fierce speculative attacks on the EMS exchange parities starting in September 1992. By august 1993, the EMS was forced to retreat to very wide (± 10 percent) bands, which is kept in force until the introduction of the euro in 1993.

Question 13

Explain why the EMS countries decided to fix their exchange rates against the German DM.

Answer 13

In this way, the other EMS countries in effect imported the credibility of the German central bank in fighting inflation, thus discouraging the development of inflationary pressures at home.

Question 14

Explain the credibility theory of the EMS.

Answer 14

In this way, the other EMS countries in effect imported the credibility of the German central bank in fighting inflation, thus discouraging the development of inflationary pressures at home. This is known as the credibility theory of the EMS.

Question 15

Why the German Bundesbank gained its low-inflation reputation?

Answer 15

Mainly, Germany’s experience with hyperinflation on the 1920s and again after World War II left the German electorate with a deeply rooted fear of inflation. The law establishing the Bundesbank singled out the defense of the DM’s real value as the primary goal of the German central bank.

Question 16

Why did the EU countries move away from the EMS toward the goal of a single shared currency?

Answer 16

(1) To produce a greater degree of European market integration by removing the threat of EMS currency realignments.
(2) Reduce German dominance of the EMS monetary policy.
(3) Given the move to complete freedom of capital movements within the EU, fixed but adjustable currency parities, may lead to ferociously speculative attacks, as in 1992-1993.
(4) To guarantee the political stability of Europe.

Question 17

To join the EMU, a country should have no more than … percent inflation rate above the average of the three EU member states with the lowest or highest inflation.

Answer 17

1.5 percent inflation rate above the average of the three EU member states with the lowest inflation.

Question 18

To join the EMU, a country must have a public-sector deficit no higher than … percent of its GDP in general.

Answer 18

To join the EMU, a country must have a public-sector deficit no higher than 3 percent of its GDP in general.

Question 19

To join the EMU, a country must have a public debt below or approaching a reference level of … percent of its GDP.

Answer 19

To join the EMU, a country must have a public debt below or approaching a reference level of 60 percent of its GDP.

Question 20

What are the biggest advantages the U.S. has over the EU in terms of being an Optimum Currency Area?
A) low mobility of labor, higher labor productivity, lower level of intra-regional trade
B) high unionization of U.S. Labor force
C) high mobility of labor force, more transfer payments between regions
D) higher uniformity of population’s taste in consumption
E) more specialized labor force and natural resource advantages

Answer 20

C

Question 21

A major economic benefit of fixed exchange rates is that they …

Answer 21

A major economic benefit of fixed exchange rates is that they simplify economic calculations and provide a more predictable basis for decisions that involve international transactions than do floating rates.

Question 22

The monetary efficiency gain from pegging say the Norwegian krone to the euro (for example) will be … if factors of production can migrate freely between Norway and the euro area.

Answer 22

The monetary efficiency gain from pegging say the Norwegian krone to the euro (for example) will be higher if factors of production can migrate freely between Norway and the euro area.

Question 23

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 23

C

Question 24

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.

Answer 24

C

Question 25

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) A fixed exchange rate automatically cushions the economy’s output and employment by allowing an immediate change in the absolute price of domestic and foreign goods.

Answer 25

C

Question 26

After Norway unilaterally pegs the krone to the euro, domestic money market disturbances will
A) no longer affect domestic output despite the continuation of float-rate regime against non-euro currencies.
B) now have major effect on domestic output despite the continuation of float-rate regime against non-euro currencies.
C) have some effect on domestic output despite the continuation of float-rate regime against non-euro currencies.
D) have major effect on domestic employment despite the continuation of float-rate regime against non-euro currencies.
E) no longer

Answer 26

A

Question 27

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) a big reduction in its price will lead to a decrease in euro zone demand for Norwegian goods that is small relative to Norway’s output. Thus, full employment can be restored fairly quickly.

Answer 27

A

Question 28

If Norway’s labor and capital markets are highly integrated with those of its euro zone neighbors
A) unemployed workers can easily move abroad to find work and domestic capital can be shifted to more profitable uses in other countries.
B) unemployed workers cannot easily move abroad to find work and domestic capital cannot be shifted to more profitable uses in other countries.
C) while unemployed workers can easily move abroad to find work, domestic capital cannot be shifted to more profitable uses in other countries.
D) while capital can easily move abroad to be put to a more profitable use, unemployed workers cannot easily move abroad to find work.
E) unemployment will rise, thanks to competition from foreign labor.

Answer 28

A

Question 29

The ability of factors to migrate abroad
A) reduces the severity of unemployment and the fall in the rate of return available to investors.
B) increases the severity of unemployment and the fall in the rate of return available to investors.
C) reduces the severity of unemployment but increases the fall in the rate of return available to investors.
D) cannot change the severity of unemployment and the constant rate of return available to investors.
E) reduces the migration of highly-skilled workers.

Answer 29

A

Question 30

The intersection of GG and LL determines
A) the optimal level of integration desired by Norway.
B) the maximum integration level desired by Norway.
C) the minimum level of integration that will cause Norway to join the fixed exchange rate regime.
D) the maximum level of integration that will cause Norway to join the fixed exchange rate regime.
E) the maximum level of integration that can aid Norway if it joins the fixed exchange rate regime.

Answer 30

C

Question 31

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 31

B

Question 32

Fiscal federalism in the EU refers to
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) the transfer of economic resources between members with healthy economies.

Answer 32

C

Question 33

Which of the following statements is MOST accurate?
A) A rise in the size and frequency of country-specific shocks raises the critical level of economic integration at which the exchange rate area is joined.
B) A rise in the size and frequency of country-specific shocks lowers the critical level of economic integration at which the exchange rate area is joined.
C) A decline in the size and frequency of country-specific shocks raises the critical level of economic integration at which the exchange rate area is joined.
D) A rise in the size and frequency of country-specific shocks has no effect on the critical level of economic integration at which the exchange rate area is joined.
E) A decline in the size and frequency of country-specific shocks does not affect the level of economic integration at which the exchange rate area is joined.

Answer 33

A

Question 34

Which of the following statements is MOST accurate?
A) A low degree of economic integration between a country and the fixed exchange rate area that it joins reduces the resulting economic stability loss due to output market disturbances.
B) A high degree of economic integration between a country and the fixed exchange rate area that it joins reduces the resulting economic stability loss due to output market disturbances.
C) A high degree of economic integration between a country and the fixed exchange rate area that it joins increases the resulting economic stability loss due to output market disturbances.
D) A complete lack of economic integration between a country and the fixed exchange rate area that it joins reduces the resulting economic stability loss due to output market disturbances.
E) A low degree of economic integration between a country and the fixed exchange rate area that it joins increases the resulting economic stability loss due to output market disturbances.

Answer 34

B

Question 35

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 35

C

Question 36

Why does the GG schedule have a positive slope?
A) The monetary efficiency gain a country gets by joining a fixed exchange rate area falls as its economic integration with the area increases.
B) The monetary efficiency gain a country gets by joining a fixed exchange rate area rises as its economic integration with the area decreases.
C) The monetary efficiency gain a country gets by joining a fixed exchange rate area rises as its economic integration with the area increases.
D) The monetary efficiency gain a country gets by joining a floating exchange rate area rises as its economic integration with the area increases.
E) The monetary efficiency gain a country gets by joining a fixed exchange rate area is constant after their integration into the area.

Answer 36

C

Question 37

Why does the LL schedule have a negative slope?
A) The economic stability loss from pegging to the area’s currencies rises as the degree of economic interdependence rises.
B) The economic stability loss from pegging to the area’s currencies falls as the degree of economic interdependence rises.
C) The economic stability loss from pegging to the area’s currencies falls as the degree of economic interdependence falls.
D) The economic stability loss from pegging to the area’s currencies rises as the degree of economic activity increases.
E) The economic stability loss from pegging to the area’s currencies is constant, even as the degree of economic activity increases.

Answer 37

B

Question 38

Compared with inter-regional trade in the he United States, intra-EU trade
A) is far greater.
B) is greater.
C) is about the same.
D) is less.
E) is far less.

Answer 38

D

Question 39

Discuss the benefits and costs of joining a fixed-exchange area.

Answer 39

Benefits: In general, gains from the stability of the area and reduced uncertainty. The efficiency 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. A major economic benefit of fixed exchange rates it that they simplify economic calculations and provide a more predictable basis for decisions that involve international transactions than do floating rates. The monetary efficiency gain from pegging, say the Norwegian krone to the euro, will be higher if factors of production can migrate freely between Norway and the euro area. The more extensive are cross-border trade and factor movements, the greater is the gain from a fixed cross-border exchange rate.
Costs: A country that joins an exchange rate area gives up its ability to use the exchange rate and monetary policy for the purpose of stabilizing output and employment. When the economy is disturbed by a change in the output market, a floating exchange rate has an advantage over a fixed rate. 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. When the exchange rate is fixed, purposeful stabilization is more difficult because monetary policy has no power at all to affect domestic output and employment.

Question 40

How mobile is Europe’s labor force?

Answer 40

Differences in language and cultural discourage labor movements between European countries. Differences in regional unemployment rates are smaller and less persistent in the United States than are differences between national unemployment rates in the European Union. Even, within European countries, labor mobility appears limited, partly because of government regulations. For example, the requirement in some countries that worker establish residence before receiving unemployment benefits makes it harder for unemployed workers to seek jobs in regions that are far from their current homes.

Question 41

What is one way to offset the economic stability loss due to fixed exchange rates?

Answer 41

Fiscal federalism is one solution in which the EU transfers economic resources from members with healthy economies to those suffering economic setbacks. These transfer payments come in the form of welfare benefits, and they are usually financed by the taxes that other member states pay. Ultimately, the extent of fiscal federalism is limited by the EU’s restricted taxation powers.

Question 42

Using the GG-LL framework, analyze the effect of an increase in the size and frequency of sudden shifts in the demand for a country’s exports.

Answer 42

Such a change pushes LL upward and to the right. Thus, the level of economic integration at which it becomes worthwhile to join the currency rises. In general, increased variability in the product markets makes countries less willing to enter fixed exchange rate areas.

Question 43

Which one of the following unexpected events ignited the 2009 euro crisis?
A) Accelerating hyperinflation and political upheaval.
B) The prospect of a sovereign default by one or more euro zone countries.
C) Rising oil prices.
D) Revolutions in Switzerland and Belgium.
E) A Chinese boycott of European products.

Answer 43

B

Question 44

What behavior by central and private banks in euro zone countries created the conditions for the 2009 euro crisis?

Answer 44

Assets were accumulated by the banks through the purchase of US financial products and through lending to other euro zone countries. Easy credit led to a European housing boom. Following the global financial crisis and the consequent recession, some European countries such as Greece Ireland Portugal Italy and Spain were found to have unsustainable levels of debt relative to national GDP. This raised the specter of a sovereign default by one or more euro zone countries and the crisis was on.

Question 45

During the 2009 euro crisis, a number of countries had private banks that had become too “big to save.” Explain.

Answer 45

A private bank is too big to save if the resources available to the home government through the central bank are insufficient to prevent bank failure. Essentially, saving the private bank would lead to a sovereign default by a countries government and so was not feasible.

Question 46

What event in 2009 ignited the euro crisis?

Answer 46

Greece elected a new government in 2009 which found that the previous government had been misreporting economic statistics for years and the public debt amounted to more than 100% of GDP. It became apparent that Greece would experience a sovereign default unless bailed out by the European Central Bank or some other source of credit.

Question 47

What is the “doom loop” responsible for the rapid development and severity of the 2009 euro crisis?

Answer 47

The “doom loop” refers to the feedback loop that runs from private bank distress to central bank distress to further private bank distress and so on, increasing in magnitude as it goes. During the euro crisis this process was evident in several euro zone countries.