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Question 1

What explains the sharply divergent long-run growth patterns?

Answer 1

The answer lies in the economic and political features of developing countries and the way these have changed over time in response to both world events and internal pressures.

Question 2

Seigniorage refers to
A) real resources a government earns when it prints money to use for spending on goods and services.
B) nominal resources a government earns when it prints money to use for spending on goods and services.
C) real resources a government earns when it prints money.
D) nominal resources a government earns when it prints money.
E) real resources a government earns when it issues bonds to use for spending on goods and services.

Answer 2

A

Question 3

Which of the following is NOT a common characteristic of a developing country?
A) extensive direct government control of the economy
B) history of low inflation
C) many weak credit institutions
D) “pegged” exchange rates
E) Agricultural commodities make up a large share of its exports.

Answer 3

B

Question 4

The relationship between annual real per-capita GDP and corruption across countries has been found to be
A) negative.
B) positive.
C) The relationship was negative in the late 1960s but is now positive.
D) The relationship was in the late 1960s but is now negative.
E) There is no relationship between these two variables.

Answer 4

A

Question 5

Which of the following are characteristic of a developing country?
A) extensive embrace of free trade policies
B) low inflation
C) high national savings
D) a current account deficit and low national savings
E) strong credit institutions

Answer 5

D

Question 6

What does it mean for a loan to be in default?
A) when the borrower of the a loan fails to repay on schedule according to a loan contract, without the agreement of the lender
B) when the borrower of a loan fails to repay on schedule according to a loan contract, with the agreement of the lender
C) when the lender of a loan fails to supplies the full amount of a loan to the borrower
D) when the lender of a loan supplies the full amount of a loan to a borrower without any promise of being repaid
E) when the lender of a loan fails to offer the promised sum

Answer 6

A

Question 7

A considerable advantage that richer countries have over poorer ones is exemplified by the fact that
A) richer countries do not have to denominate their foreign debts in their own currencies.
B) richer countries have the ability to denominate their foreign debts in foreign currencies.
C) when demand falls for a poorer country’s goods, this leads to a significant wealth transfer from foreigners to the poorer country, a kind of international insurance payment.
D) richer countries have the ability to denominate their foreign debts in their own currencies.
E) richer countries can extract trade advantages by using military power.

Answer 7

D

Question 8

In 1981-1983, the world economy suffered a steep recession. Naturally, the fall in industrial countries’ aggregate demand had a direct negative impact on the developing countries. What other mechanism was an even more important contributor to this event?
A) the immediate steep inflation that followed the recession
B) the dollar’s sharp depreciation in the foreign exchange market
C) the increase in primary commodity prices, increasing terms of trade in many poor countries
D) the collapse in primary commodity prices and the immediate, large rise in the interest burden that debtors had to pay
E) the influx of defaulting credit

Answer 8

D

Question 9

In 1991, Argentina established a radical institutional reform after experiencing a decade marked by financial instability. This program was called the new Convertibility Law. What did this law do?
A) made Argentina’s currency fully convertible into Eurocurrency at a fixed rate
B) required that the monetary base be backed completely by U.S. dollars
C) placed limits on exports of commodities
D) made Argentina’s currency fully convertible into U.S. dollars at a fixed rate and required that the monetary base be backed completely by gold or foreign currency
E) restricted risky international trade activity

Answer 9

D

Question 10

How would you define exchange control?
A) The government allocates foreign exchange through decree rather than through the market.
B) a country NOT pegging its exchange rate
C) a country pegging its exchange rate
D) a country buying up excess current account so that CA=0
E) a country restricting all foreign exchange

Answer 10

A

Question 11

Which of the following is a reason that developing countries are running large surpluses?
A) They are required to do so by IMF.
B) They have defaulted on international loans.
C) They have pegged exchange rates and thus the growth of exports must drive surplus up.
D) They have a strong desire to accumulate international reserves to protect against a sudden stop of capital inflows.
E) They don’t know how to manage their surpluses.

Answer 11

D

Question 12

The following are all the forms of debt finance.
A) bond, bank, and official finance
B) bond and bank finance
C) bond, bank, and portfolio finance
D) foreign direct and portfolio investment
E) direct investment, stock, and dividends

Answer 12

A

Question 13

Why may equity finance be preferred to debt finance for developing countries?
A) A fall in domestic income automatically reduces the earnings of foreign shareholders without violating any loan agreement.
B) There are laws insuring against any default with equity finance.
C) The risk is shared between debtor and creditor with debt finance.
D) The tax structure leaves equity finance unconstrained.
E) Repayments are unaffected by falls in real income.

Answer 13

A

Question 14

Since foreign credit dries up in crises when it is most needed, developing countries can protect themselves from default by
A) cutting off imports of goods.
B) allowing the exchange rate to float.
C) using equity finance only.
D) accumulating high levels of international reserves.
E) avoiding the international capital market.

Answer 14

D

Question 15

What factors lie behind capital inflows to the developing world?

Answer 15

Many developing countries have received a lot of capital inflows that lead them to a huge debt to foreigners. These debts are been produced because the economy of the developing world is very small compared to the economy of the industrial world. Since developing countries face a lot of poverty and poor financial institutions, national savings is often low and because of that, they are always facing current account deficit. Even though, these countries are very poor in capital, there are opportunities for profitable introduction or expansion of firms and equipments, and these opportunities give good reason for a high level of investment. However, because these countries always have deficits in their current account, a country can obtain resources from abroad to invest even if its domestic savings level is low. This means that the country is going to have to borrow money from a foreign country. These ways of production are the one that lie behind capital inflows because by helping these countries to grow and expand, the price to be pay is a big debt which they know based on their circumstances its going to be hard to repaid.

Question 16

Explain why the distinction between debt and equity finance is useful in analyzing the response of developing countries to unforeseen events such as recession.

Answer 16

When a country’s liabilities are in the form of debt, its fixed scheduled payments to creditors do not fall when its real income falls. This makes it difficult to honor the developing country’s foreign obligations and may lead to default.

Question 17

The 1980s are considered as the “lost decade” of Latin American growth. Explain why?

Answer 17

Just as the Great Depression made it hard for developing countries to make payments on their foreign loans, the great recession of the 1980s also sparked a crisis over developing country debt. The fall in the industrial countries’ aggregate demand had a direct negative impact on the developing countries. The problem was make worse by the dollar’s sharp appreciation in the foreign exchange market, which raised the real value of the dollar debt burden substantially. The crisis began in August 1982 when Mexico announced that its central bank had run out of foreign reserves and that it could no longer meet payments on its $80 billion in foreign debt. Seeing potential similarities between Mexico and other large Latin American debtors such as Argentina, Brazil, and Chile, banks in the industrial countries, the largest private lenders to Latin America scrambled to reduce their risks by cutting off new credits and demanding repayment on earlier loans. The result was a widespread inability of developing countries to meet prior debt obligations, and a rapid move to the edge of a generalized default. Latin America was perhaps hardest hit, but so were soviet bloc countries like Poland that had borrowed from the European banks. Nonetheless, by the end of 1986 more than 40 countries had encountered severe financing problems. Growth had slowed sharply in much of the developing countries because they have to stop producing in order to pay the debtors.

Question 18

The main reason for the crisis in Argentina in 2001 and 2002, as to do with exchange rate policy, i.e., the continued peg of the exchange rate to the dollar. Discuss.

Answer 18

Student should emphasize that the quote is mainly true. Students should compare Argentina in those years with the better experience of Chile and Mexico with flexible exchange rates and emphasize the appreciation of the dollar.

Question 19

“Sharp contractions in a country’s output and employment invariably result from a crisis in which the country suddenly loses access to all foreign sources of funds.” Explain how the current account identity necessitates these contractions.

Answer 19

S - I = CA (Current Account Identity)
Imagine that a country is running a current account deficit (i.e. borrowing from abroad) a certain amount of its GNP when foreign lenders suddenly become scared of default and cut off all new loans. This action causes the current account balance to be at least 0 due to either a rise in saving or a fall in investment (or a combination of both). The required sharp fall in aggregate demand necessarily depresses the country’s output dramatically.

Question 20

What weakness in the economic structures of Asian countries contributed to the severe financial crisis that Asian economies experienced in 1997?
A) Productivity: It increased rapidly and the countries were victims of their own success
B) Banking regulation: Banks were excessively regulated, which reduced profits.
C) Legal Framework: The system dealt unsuccessfully with companies in financial trouble
D) Natural Resources: Countries’ lack of natural resources and failure to explore developing industries accumulated and led to the crisis.
E) High Taxes: High rates of taxation resulted in a reliance on imports.

Answer 20

C

Question 21

What event started the Asian financial crisis in 1997?
A) Indonesia’s inability to pay its debts
B) devaluation of Indonesia’s currency
C) Thailand’s inability to pay its debts
D) devaluation of Thailand’s currency
E) devaluation of Malaysia’s currency

Answer 21

D

Question 22

How would you define a currency board?
A) the process by which non-pegged interest rates are allowed to fluctuate
B) the stockpiling of international reserves by developing countries
C) using the dollar to carry out all domestic transactions, making the domestic currency a currency in name alone
D) a constraint placed on monetary policy
E) The monetary bases is backed entirely by foreign currency and the central bank holds no domestic assets.

Answer 22

E

Question 23

If a developing country institutes a currency board, it relinquishes control over having
A) monetary policy autonomy.
B) exchange rate stability.
C) freedom of capital movement.
D) freedom of labor movement.
E) all of its funds.

Answer 23

A

Question 24

Compare currency board to conventional fixed exchange rate.

Answer 24

Currency board may not acquire domestic assets and thus cannot lend currency freely to domestic banks in time of financial crisis. Also, limit government ability to “surprise” the market and have real devaluation.

Question 25

Which of the following economic lessons should we take from developing country crises in Latin America (and elsewhere)?
A) Only that it is important to choose the right exchange rate regime.
B) Only that banking is of central importance in any government.
C) The order in which reform measures are implemented are irrelevant.
D) It is important to choose the right exchange rate regime and banking is of central importance in any government.
E) The order in which reform measures are implemented are irrelevant and banking is of central importance in any government.

Answer 25

D

Question 26

“Developing countries should delay opening the capital account until the domestic financial system is strong enough to withstand the sometimes violent ebb and flow of world capital.” Discuss.

Answer 26

Probably true. The issue is related to the theory of second best and the proper sequence of reform measures. Of course, students may argue against such step-by-step measures.