7

Question 1

what is the principle behind the balance sheet recording of transactions?

Answer 1

double-entry bookkeeping: each transaction enters the balance sheet twice

Question 2

What are the 2 categories composing the balance sheet?

Answer 2

assets and liabilities

Question 3

what are the types of assets of the balance sheet (3)?

Answer 3

• domestic gvt bonds
• loans to domestic banks
• foreign exchange reserves

Question 4

what are the types of liabilities of the balance sheet (3)?

Answer 4

• commercial banks reserves (deposits held by private banks)
• currency
• capital

Question 5

A central bank’s international reserves consists of its holdings of

A) gold.

B) silver and gold.

C) foreign assets and gold.

D) domestic assets and precious metals.

E) foreign and domestic currency holdings.

Answer 5

C

Question 6

The liabilities side of a central bank’s accounts consists of

A) deposits held by private banks.

B) currency in circulation.

C) deposits held by private banks and currency in circulation.

D) deposits held by foreign banks, domestic assets, and currency in circulation.

E) foreign assets and domestic assets.

Answer 6

C

Question 7

Which one of the following statements is most correct?

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) Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets does not necessarily affect the money supply.

Answer 7

A

Question 8

Please write the new balance sheet if the bank sells $100 worth of foreign bonds for domestic currency.

Answer 8

Foreign assets decrease by 100$

Currency in circulation decrease by 100$

Question 9

Please write the new balance sheet if the bank purchased $100 in foreign bonds by writing a check on itself.

Answer 9

foreign assets increase by 100$

deposits held by private banks increase by 100$

Question 10

Please write the new balance sheet if the bank makes a sterilized transaction by selling $100 of foreign assets for domestic currency and then purchasing $100 of domestic assets by writing a check on itself.

Answer 10

foreign asset decrease by 100$

domestic assets increase by 100$

deposits held by privates banks increase by 100$

currency in circulation decrease by 100$

Question 11

If the central bank does not purchase foreign assets when output increases but instead holds the money stock constant, can it still keep the exchange rate fixed at E0?

Answer 11

No, the rise in output leads to an excess demand for money. If the central bank does not increase supply to meet this demand, the domestic interest rate would rise above the foreign rate, R*. This higher rate of return (and given expectations in the foreign exchange market) would cause the exchange rate to fall below E0.

Question 12

Under fixed exchange rate and in the absence of capital controls:

A) the domestic and foreign interest rates are equal, R = R*.

B) R = R* + (Ee - E)/E.

C) the foreign and domestic interest rates are unequal.

D) the expected rate of domestic currency depreciation is high.

E) the expected rate of currency depreciation is one.

Answer 12

A

Question 13

Under fixed exchange rate and in the absence of capital controls, in general which one of the following statements is the MOST accurate?

A) The following condition should hold for domestic money market equilibrium: Ms/P = L(R*, Y).

B) The following condition should hold for domestic money market equilibrium: Md/P = L(R*, Y).

C) The following condition should hold for domestic money market equilibrium: Ms = L(R*, Y).

D) The following condition should hold for domestic money market equilibrium: P = L(R*, Y).

E) The following condition should hold for domestic money market equilibrium: R*Md/P = L(Y).

Answer 13

A

Question 14

Which one of the following statements is the MOST accurate?

A) Under a fixed exchange rate, central bank monetary tools are powerless to affect the economy’s money supply.

B) Under a flexible exchange rate, central bank monetary tools are powerless to affect the economy’s money supply or its output.

C) Under a fixed exchange rate, fiscal policy tools are powerless to affect the economy’s money supply or its output.

D) Under a fixed exchange rate, central bank monetary tools are powerless to affect the economy’s money supply or its output if capital can move freely.

E) Under a dirty float exchange rate, central bank monetary tools are powerless to affect the economy’s money supply or its output.

Answer 14

D

Question 15

Absent capital controls, 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 15

E

Question 16

Fiscal expansion under fixed exchange rates will have what temporary effect?

A) the money supply will decrease.

B) output will decrease.

C) the exchange rate will increase.

D) the exchange rate will decrease.

E) there will be no effect.

Answer 16

D

Question 17

When a country’s currency is devalued

A) output decreases.

B) output increases and the money supply decreases.

C) the money supply decreases.

D) output decreases and the money supply increases.

E) both the output and the money supply increases.

Answer 17

E

Question 18

Under fixed rates (and absent capital controls), which one of the following statements is the MOST accurate?

A) Monetary policy can affect only output.

B) Monetary policy can affect only employment.

C) Monetary policy can affect only international reserves.

D) Monetary policy can not affect international reserves.

E) Monetary policy can only affect money supply.

Answer 18

C

Question 19

Under a fixed exchange rate, which one of the following statements is the MOST accurate?

A) Fiscal policy can affect output, employment and international reserves at the same time.

B) Fiscal policy can affect only employment.

C) Fiscal policy can affect only international reserves.

D) Fiscal policy can affect only output and employment.

E) Fiscal employment can affect only output and international reserves.

Answer 19

A

Question 20

Under a fixed exchange rate, which one of the following statements is the MOST accurate?

A) Fiscal policy can affect output, employment and international reserves at the same time.

B) Fiscal policy can affect only employment.

C) Fiscal policy can affect only international reserves.

D) Fiscal policy can affect only output and employment.

E) Fiscal employment can affect only output and international reserves.

Answer 20

C

Question 21

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) A devaluation occurs when the central bank raises the foreign currency price of domestic currency, E, and a revaluation occurs when the central bank lowers E.

Answer 21

B

Question 22

Which one of the following statements is the MOST accurate?

A) Depreciation is a rise in E when the exchange rate is fixed while devaluation is a rise in E when the exchange rate floats.

B) Depreciation is a decrease in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.

C) Depreciation is a rise in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.

D) Depreciation is a rise in E when the exchange rate floats while devaluation is a decrease in E when the exchange rate is fixed.

E) Depreciation is a fall in E when the exchange rate is fixed while devaluation is a fall in E when the exchange rate floats.

Answer 22

C

Question 23

Which one of the following statements is the MOST accurate?

A) Appreciation is a rise in E when the exchange rate floats while revaluation is a fall in E when the exchange rate is fixed.

B) Appreciation is a fall in E when the exchange rate floats while revaluation is a fall in E when the exchange rate is fixed.

C) Appreciation is a fall in E when the exchange rate is fixed while revaluation is a fall in E when the exchange rate is flexible.

D) Appreciation is a fall in E when the exchange rate floats while revaluation is a rise in E when the exchange rate is fixed.

E) Appreciation is a rise in E when the exchange rate floats while revaluation is a rise in E when the exchange rate is fixed.

Answer 23

B

Question 24

Under fixed exchange rates, 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 24

B

Question 25

Under fixed exchange rates, 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 25

C

Question 26

The main reason(s) why governments sometimes chose to devalue their currencies is (are)

A) devaluation makes domestic goods more expensive in relation to foreign goods.

B) devaluation makes domestic services more expensive in relation to foreign services.

C) devaluation increases foreign reserves held by the central bank.

D) devaluation improves the current account and increases foreign reserves held by the central bank.

E) devaluation hurts foreign currencies.

Answer 26

D

Question 27

What are the actions the central bank must take to maintain a fixed exchange rate following an increase in output.

Answer 27

A rise in output from Y1 to Y2 will increase the real money demand, so the central bank must purchase foreign assets and raise the money supply from M1 to M2, in order to maintain a fixed exchange rate E0.

Question 28

A balance of payments crisis is best described as

A) a sharp change in interest rates sparked by a change in expectations about the level of imports.

B) a sharp change in foreign reserves sparked by a change in expectations about the future exchange rate.

C) a sharp change in interest rates sparked by a change in expectations about the level of exports.

D) a sharp change in foreign reserves sparked by a change in expectations about the level of imports.

E) a sharp change in foreign reserves sparked by a change in expectations about domestic production.

Answer 28

B

Question 29

The expectation of future devaluation causes a balance of payments crisis marked by

A) a sharp rise in reserves and a fall in the home interest rate below the world interest rate.

B) a sharp fall in reserves and an even bigger fall in the home interest rate below the world interest rate.

C) a sharp fall in reserves and a rise in the home interest rate above the world interest rate.

D) a sharp rise in reserves and an even greater rise in the home interest rate above the world interest.

E) a sharp rise in reserves and a rise in the home interest rate to the level of the world interest.

Answer 29

C

Question 30

The expectation of future revaluation causes a balance of payments crisis marked by

A) a sharp rise in reserves and a fall in the home interest rate below the world interest rate.

B) a sharp fall in reserves and an even bigger fall in the home interest rate below the world interest rate.

C) a sharp fall in reserves and a rise in the home interest rate above the world interest rate.

D) a sharp rise in reserves and an even greater rise in the home interest rate above the world interest.

E) a sharp fall in reserves and an unchanged home interest rate.

Answer 30

A

Question 31

Capital flight

A) increases reserves.

B) is never associated with the expectation of devaluation.

C) may undo expected devaluation.

D) reduces losses during a devaluation scare.

E) decreases reserves and may induce devaluation.

Answer 31

E

Question 32

Currency crises may result from

A) central bank balance sheets with higher liabilities than assets.

B) political upheaval leading to lowering exports.

C) a reconfiguration of central bank balance sheets.

D) speculative attacks on the currency or central banks purchasing excessive amounts of government bonds.

E) depreciation of foreign reserves.

Answer 32

D

Question 33

Use a figure to explain the potential effectiveness of fiscal policy to spur on the economy under a fixed exchange rate.

Answer 33

With an aim toward increasing output, the government could use fiscal policy to shift the DD curve outward. The central bank will have to take steps to maintain a fixed exchange rate E0, among the options is buying foreign assets with money, to shift the AA schedule outward until the equilibrium at point 3 is reached.

Question 34

Show the effect of a currency devaluation on the economy.

Answer 34

A devaluation occurs when the central bank raises the domestic currency price of foreign currency. In the figure, the domestic currency is devalued from E0 to E1. Since nothing in the DD schedule has changed, the new equilibrium at point 2 must be reached by an expansion of the money supply (AA curve shifts outward). Notice also that output has increased from Y1 to Y2 .

Question 35

Discuss whether or not a devaluation under a fixed exchange rate has the same long-run effect on output as a proportional increase in the money supply under a floating rate.

Answer 35

A currency devaluation shifts the AA schedule outward from equilibrium point 1 to equilibrium point 2. The devaluation does not change long-run demand or supply conditions in the output market. Thus, the increase in the long-run price level will exactly offset the increase in exchange rate. Thus, a devaluation is neutral in the long run and this is the exact same scenario as for an increase in the money supply under a floating exchange rate.

Question 36

Imperfect asset substitutability implies

A) the returns on foreign and domestic currency bonds are identical.

B) the returns on foreign and domestic currency are unrelated.

C) the risks of holding foreign and domestic currency are identical.

D) the risks of holding foreign and domestic currency are unrelated to returns.

E) the returns on foreign and domestic currency differ and are influenced by risk.

Answer 36

E

Question 37

When domestic and foreign currency bonds are imperfect substitutes, the domestic interest rate (R) can be written as

A) R = R - (Ee - E)/E + ρ.

B) R = R - (Ee - E)/E.

C) R = R + (Ee - E)/E + ρ.

D) R = R - (Ee + E)/E + ρ.

E) R = R - (Ee - E)ρ.

Answer 37

C

Question 38

In the interest rate parity condition with imperfect substitutes and a risk premium of ρ

A) an increased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.

B) a decreased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.

C) an increased stock of domestic government debt will reduce the difference between the expected returns on domestic and foreign currency bonds.

D) an increased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.

E) a decreased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.

Answer 38

A

Question 39

Use a figure to explain how a balance of payments crisis and its hand in capital flight.

Answer 39

Suppose the foreign exchange market expects the government to devalue the currency in the future and adopt a new fixed exchange rate E1 > E0 . This leads to a rightward shift in the curve that measures the expected domestic currency return on foreign currency deposits. Since the exchange rate remains fixed at E0, the domestic interest rate must rise to R* + ( E1 - E0 )/E0. The central bank must sell foreign reserves and shrink the money supply in response. This reserve loss accompanying a devaluation scare is labeled capital flight.

Question 40

Use a figure to show the effect of a sterilized central bank purchase of foreign assets under the imperfect asset substitutability assumption.

Answer 40

The interest parity condition is given by

R = R* + ( E0 - E)/E + e(B-A)

Suppose that the domestic assets of the central bank fall from A1 to A2 through a sterilized purchase of foreign assets. Then the risk-adjusted return increases and the exchange rate increases.

Question 41

Balance of payments crises under fixed exchange rates occur because of

A) government policies that are inconsistent with fixed exchange rates.

B) punitive currency wars.

C) global inflation and trade imbalances due to war.

D) excessive exports and imports that overload the global system.

E) monotonic expansion in global currency volume.

Answer 41

A

Question 42

A balance of payments crises under fixed exchange rates occurs when

A) a country runs out of foreign reserves.

B) a country is in a liquidity trap.

C) exports and imports expand beyond some point.

D) marginal returns on foreign exchange investments approach zero.

E) forward currency markets undergo high volatility.

Answer 42

a

Question 43

A country seeking to maintain internal balance would be concerned

A) only with attaining low levels of unemployment.

B) primarily with ensuring that saving is weighted more towards domestic investment than the current account.

C) with large fluctuations in output or prices.

D) with maintaining an adequate stock of gold reserves.

E) with stabilizing employment levels globally.

Answer 43

C

Question 44

A current account surplus

A) poses a problem if domestic savings are being invested more profitably abroad than they would be at home.

B) may pose no problem if domestic savings are being invested more profitably abroad than they would be at home.

C) may pose no problem if domestic savings are being invested less profitably abroad than they would be at home.

D) there is no relation between current account surplus and between savings and investment.

E) poses a problem if domestic savings are being invested less profitably abroad than they would be at home.

Answer 44

B

Question 45

A current account deficit

A) will not pose a problem, especially if it is accompanied by an expansionary fiscal policy.

B) may pose no problem if the borrowed funds are channeled into productive domestic investment projects that pay for themselves with the revenue they generate in the future.

C) may still pose a problem, even if the borrowed funds are channeled into productive domestic investment projects.

D) There is no relation between current account surplus and between savings and investment.

E) will pose a problem because the country is borrowing funds from the rest of the world that it won’t be able to pay back later.

Answer 45

B

Question 46

Which one of the following statements is TRUE?

A) Countries with strong investment opportunities should invest little at home and channel their savings into more productive investment activity abroad.

B) Countries with weak investment opportunities should invest little at home and channel their savings into more productive investment activity abroad.

C) Countries with weak investment opportunities should invest more at home.

D) Countries with weak investment opportunities should invest little abroad.

E) Countries with weak investment opportunities should invest little abroad and channel their savings into more productive investment activity domestically.

Answer 46

B

Question 47

Countries with

A) strong investment opportunities should invest little at home and channel their savings into more productive investment activity abroad.

B) strong investment opportunities should invest more at home and less abroad.

C) weak investment opportunities should invest more at home.

D) weak investment opportunities should invest little abroad.

E) countries with productive investment should invest exclusively at home.

Answer 47

B

Question 48

Governments prefer to avoid excessive current account surpluses because

A) the returns to domestic savings are more difficult to tax than those on assets abroad.

B) an addition to the home capital stock may increase domestic unemployment and therefore lead to higher national income.

C) foreign investment in one firm may have beneficial technological spillover effects on other foreign producers that the investing firm does not capture.

D) an addition to the home capital stock may reduce domestic unemployment and therefore lead to higher national income.

E) domestic savings increase with more investment abroad.

Answer 48

D

Question 49

Why do governments prefer to avoid current account deficits that are too large?

Answer 49

A current account deficit may pose no problem if the borrowed funds are channeled into productive domestic investment projects that pay for themselves with the revenue they generate in the future. However, sometimes, large current account deficits represent temporarily high consumption resulting from misguided government policies or some other malfunctioning of the economy. Sometimes, the investment projects that draw on foreign funds may be badly planned, etc. In such cases, the government might wish to reduce the current account deficit immediately rather than face problems in repaying its foreign debt in the future.

Question 50

Why do governments prefer to avoid excessive current account surpluses? Or, why are growing domestic claims to foreign wealth ever a problem?

Answer 50

For a given level of national saving, an increased current account surplus implies lower investment in domestic plant and equipment. A few reasons why: first, the returns to domestic savings may be easier to tax than those on assets abroad; second, an addition to the home capital stock may reduce domestic unemployment and therefore lead to higher national income; third, domestic investment by one firm may have beneficial technological spillover effects on other domestic producers that the investing firm does not capture. In addition, the country may in the future find itself unable to collect the money it is owed. Furthermore, countries with large surpluses can become targets for discriminatory protectionist measures by trading partners with external deficits.

Question 51

Which of the following is one component of the “trilemma” that is faced by policy makers in choosing monetary arrangements?

A) exchange rate stability

B) restrictions on international capital movements

C) tariffs and subsidies

D) restrictions on the migration of labor

E) global inflation

Answer 51

A

Question 52

Which of the following is one component of the “trilemma” that is faced by policy makers in choosing monetary arrangements?

A) freedom of international capital movements

B) exchange rate instability

C) tariffs and subsidies

D) restrictions on the migration of labor

E) global inflation

Answer 52

A

Question 53

Which of the following is one component of the “trilemma” that is faced by policy makers in choosing monetary arrangements?

A) monetary policy oriented towards domestic goals

B) exchange rate instability

C) tariffs and subsidies

D) restrictions on the migration of labor

E) global inflation

Answer 53

A

Question 54

Countries with large current account surpluses might be viewed by the market as candidates for

A) devaluation.

B) revaluation.

C) bankruptcy.

D) depreciation.

E) investment.

Answer 54

B

Question 55

In order to bring about a real depreciation of the dollar, the U.S. can hope for

A) a rise in the U.S. price level.

B) a fall in foreign price levels.

C) a rise in the dollar’s nominal value in terms of foreign currencies.

D) a rise in foreign price levels or a fall in the dollar’s nominal value in terms of foreign currencies.

E) increased output and full employment.

Answer 55

D

Question 56

Advocates of floating rate suggested it is favorable for economies for all of the following reasons EXCEPT

A) it discourages attack from foreign exchange speculators because of the fact that exchange rate adjustment is immediate.

B) it helps stabilize the shock effect on unemployment in case of economic changes such as fall in export demand.

C) it automatically matches the domestic inflation with ongoing foreign inflation.

D) it gives every country the opportunity to guide its own monetary conditions at home.

E) it brings the LR exchange rate to the level predicted by PPP without government policy decisions.

Answer 56

C

Question 57

Which of the following is NOT a result of a temporary fall in foreign demand on one country’s exports under floating exchange rate?

A) The DD curve shifts to the left due to reduction of aggregate demand.

B) The AA curve shifts downwards due to reduction of money supply.

C) a fall in aggregate output

D) depreciation in home country’s currency

E) a fall in the home interest rate

Answer 57

B

Question 58

Which of the following is NOT a result of a permanent fall in foreign demand on one country’s exports under floating exchange rate?

A) The DD curve shifts to the left due to reduction of aggregate demand.

B) The AA curve shifts upwards due to the increased expected long-run exchange rate.

C) a reduction in output by a smaller degree compared to temporary fall in demand

D) depreciation in home country’s currency

E) a raised level of unemployment

Answer 58

E

Question 59

Which one of the following is/are INCORRECT?

An argument against floating exchange rates is that

A) a fixed rate automatically prevents instability in the domestic money market from affecting the economy if shocks come from home domestic money market.

B) a fixed rate might become unpredictable, complicating economic planning.

C) a rise in money demand under a fixed exchange rate would have no effect on the exchange rate and output.

D) a fixed rate functions within the price-specie-flow mechanism and maintains a balance of payments equilibrium.

E) a fixed rate automatically prevents instability in the economy from output market shocks.

Answer 59

E

Question 60

If central banks were no longer obliged to intervene in currency markets to fix exchange rates, governments would be able to use monetary policy to reach

A) internal balance.

B) external balance.

C) internal and external balance.

D) internal but not external balance.

E) external but not internal balance.

Answer 60

C

Question 61

Advocates of flexible exchange rates claim that under flexible exchange rates

A) no country would be forced to import only inflation from abroad.

B) no country would be forced to import only deflation from abroad.

C) no country would be forced to import inflation and deflation from abroad.

D) flexible exchange rates are not able to halt importing inflation from abroad.

E) flexible exchange rates are not able to halt importing deflation from abroad.

Answer 61

C

Question 62

Advocates of floating rates pointed out that

A) removal of the obligation to peg currency values would restore monetary control to central banks.

B) imposing of the obligation to peg currency values would restore monetary control to central banks.

C) removing of the obligation to peg currency values would restore fiscal control.

D) imposing of the obligation to peg currency values would restore fiscal control.

E) imposing of the obligation to peg currency would restore monetary control to the consumer.

Answer 62

A

Question 63

Advocates of flexible exchange rates claim that under flexible exchange rates, if the central bank faced unemployment

A) and thus wished to decrease its money supply, there would no longer be any legal barrier to the currency depreciation this would cause.

B) and thus wished to expand its money supply, there would no longer be any legal barrier to the currency depreciation this would cause.

C) and wished to expand its money supply, there would no longer be any legal barrier to the currency appreciation this would cause.

D) and wished to decrease its money supply, there now would be a legal barrier to the currency depreciation this would cause.

E) and wished to increase output, there would no longer be a legal barrier to the currency appreciation this would cause.

Answer 63

B

Question 64

Advocates of flexible exchange rates claim that under flexible exchange rates, a currency

A) appreciation caused by increasing the money supply would reduce unemployment by lowering the relative price of domestic products.

B) depreciation caused by increasing the money supply would increase unemployment by lowering the relative price of domestic products.

C) depreciation caused by increasing the money supply would reduce unemployment by lowering the relative price of domestic products.

D) depreciation caused by increasing the money supply would reduce unemployment by increasing the relative price of domestic products.

E) depreciation cause by decreasing the money supply would not effect unemployment, but would increase the relative price of domestic products.

Answer 64

C

Question 65

Advocates of flexible exchange rates claim that under flexible exchange rates, a currency

A) depreciation caused by increasing the money supply would reduce unemployment by lowering the relative price of domestic products and increasing the world demand for them.

B) appreciation caused by increasing the money supply would reduce unemployment by lowering the relative price of domestic products and increasing world demand for them.

C) appreciation caused by decreasing the money supply would reduce unemployment by lowering the relative price of domestic products and increasing world demand for them.

D) appreciation caused by increasing the money supply would increase unemployment by lowering the relative price of domestic products and increasing world demand for them.

E) appreciation caused by increasing the money supply would increase unemployment by lowering the relative price of domestic products and by decreasing world demand for them.

Answer 65

A

Question 66

Under flexible exchange rate, the response of an economy to a temporary fall in foreign demand for its exports is

A) the currency appreciates, and output falls.

B) the currency depreciates, and output falls.

C) the currency depreciates, and output increases.

D) the currency depreciates, and output remains constant.

E) the currency appreciates, and output increases.

Answer 66

B

Question 67

Under fixed exchange rate, the response of an economy to a temporary fall in foreign demand for its exports is

A) the currency appreciates, and output falls.

B) the currency depreciates, and output falls.

C) the currency remains the same, and output decreases.

D) the currency depreciates, and output remains constant.

E) the currency appreciates, and output remains the same.

Answer 67

C

Question 68

Comparing fixed to flexible exchange rate, the response of an economy to a temporary fall in foreign demand for its exports is

A) output actually falls less under fixed rate than under floating rate.

B) output actually falls more under fixed rate than under floating rate.

C) output actually remains the same under fixed rate than under floating rate.

D) the currency value grows in a fixed rate system and falls in a flexible system.

E) output grows in a fixed rate system and falls in a flexible system.

Answer 68

B

Question 69

Under the flexible exchange rate, lowering the price of a foreign currency will

A) allow the expansion of monetary policy without causing inflation.

B) decrease the foreign country’s output.

C) prevent a foreign price increase from causing deflation at home.

D) cause a home price increase to be exported to the foreign markets.

E) cause a “beggar-thy-neighbor” effect.

Answer 69

A

Question 70

The mechanism behind the inflation insulation provided by a floating exchange rate is

A) Purchasing Power Parity.

B) a fixed AA curve.

C) market speculation.

D) tight monetary policy.

E) symmetry.

Answer 70

A

Question 71

If the demand for Home exports decreased abroad, the Home fall in output would be greatest

A) if the decrease was temporary and the exchange rate was fixed.

B) if the decrease was temporary and the exchange rate was floating.

C) if the decrease was permanent and the exchange rate was fixed.

D) if the decrease was permanent and the exchange rate was floating.

E) if the decrease was permanent and the exchange rate was high.

Answer 71

C

Question 72

Use the DD-AA model to examine and compare the response of an economy under fixed and floating exchange rate to a temporary fall in foreign demand for its exports.

Answer 72

• The DD curve shifts to the left. When the exchange rate floats, because the demand shift is assumed to be temporary, it does not change the long-run expected exchange rate and so does not move the asset market equilibrium schedule AA. Thus, E rises, i.e. the currency depreciates and output falls.*
• Under fixed exchange rate, the central bank must prevent the currency depreciation that occurs under a floating rate; thus, it buys domestic money with foreign currency, reducing the domestic money supply and shifting the AA to the left and down. E will remain constant and output will fall.*

Question 73

Use the DD-AA model to examine and compare the response of an economy under fixed and floating exchange rate to a permanent fall in foreign demand for its exports.

Answer 73

• The DD curve shifts to the left. Under flexible exchange rate, the expected exchange rate Ee also rises and AA shifts upward and to the right. Thus, a permanent shock causes a greater depreciation than a temporary one.*
• Under fixed exchange rate, the central bank must prevent the currency depreciation that occurs under a floating rate; thus, it buys domestic money with foreign currency, reducing the domestic money supply and shifting the AA to the left and down. E will remain constant and output will fall.*
• Under fixed exchange rate, a fall in export demand if permanent have led to a situation of “fundamental disequilibrium” calling for a devaluation of the currency or a long period of domestic unemployment as export prices fell. Uncertainty about the government’s intention would have encouraged speculative capital outflows, further worsening the situation by depleting central bank reserves and contracting the domestic money supply at a time of unemployment.*

Question 74

Use the DD-AA model to compare the domestic economic response under flexible and fixed exchange rate regimes to a temporary rise in export demand from foreign countries.

Answer 74

• Under floating rate: The DD curve shifts right. AA does not change because the temporary increase will not affect the long run expected exchange rate. Output rises and E falls (depreciates).*
• Under fixed rate: The DD curve shifts right. The central bank intervenes to prevent a change in the exchange rate. By selling domestic currency they expand the domestic supply and the AA curve shifts right, keeping E constant. Output however will rise due to the new equilibrium of the DD and AA curves to the right of its former location.*

Question 75

Under a flexible exchange rate regime, an increase in real money demand

A) moves the AA curve to the right.

B) moves the AA curve to the left.

C) leaves the AA curve unchanged.

D) moves the DD curve to the right.

E) moves the DD curve to the left.

Answer 75

B

Question 76

If most of the shocks that buffet the economy come from the output market shocks, then

A) fixed exchange rates are better than flexible exchange rates.

B) flexible exchange rates are better than fixed exchange rates.

C) which system is chosen is not important.

D) fixed exchange rates are better than flexible exchange rates only in the short run.

E) flexible exchange rates are better than fixed exchange rates only in the short-run.

Answer 76

B

Question 77

In the case of a domestic monetary shock, floating exchange rates

A) make the home economy less vulnerable.

B) make the home economy more vulnerable.

C) make the foreign economy more vulnerable.

D) would not affect the foreign economy.

E) would not affect the home economy.

Answer 77

B

Question 78

Under floating rates, the economy is more vulnerable to shocks coming from the domestic money market.” Discuss.

Answer 78

• The statement is true. Under floating rates, a rise in real domestic money demand causes income to fall and to an appreciation of the domestic currency. If the rise in real domestic money supply is permanent, it will lead eventually to a fall in the home price level.*
• Under a fixed exchange rate, the change in real money demand does not affect the economy at all. To prevent the home currency from appreciating, the central bank buys foreign reserves with domestic money until the real money supply rises by an amount equal to the rise in real money demand. This intervention has the effect of preventing any change in output or the price level.*