Chapter 12 : The Open Economy

Question 1

Compared to a closed economy, an open economy is one that:

(A) allows the exchange rate to float.
(B) fixes the exchange rate.
(C) trades with other countries.
(D) does not trade with other countries.

Answer 1

(B) trades with other countries.

Question 2

The Mundell-Fleming model assumes that:
(A) prices are flexible, whereas the IS–LM model assumes that prices are fixed.
(B) prices are fixed, whereas the IS–LM model assumes that prices are flexible.
(C) as in the IS–LM model, prices are fixed.
(D) as in the IS–LM model, prices are flexible.

Answer 2

(C) as in the IS–LM model, prices are fixed.

Question 3

The Mundell-Fleming model is a \_\_\_\_\_\_ model for a \_\_\_\_\_\_ open economy.
(A) short-run; small
(B) short-run; large 
(C) long-run; large 
(D) long-run; small

Answer 3

(A) short-run; small

Question 4

In the Mundell-Fleming model:
(A) the exchange rate system must have a floating exchange rate.
(B) the exchange rate system must have a fixed exchange rate.
(C) it makes no difference whether the exchange rate system has a floating or a fixed exchange rate.
(D) the behavior of the economy depends on whether the exchange rate system has a floating or a fixed exchange rate.

Answer 4

(D) the behavior of the economy depends on whether the exchange rate system has a floating or a fixed exchange rate.

Question 5

In the Mundell-Fleming model, the domestic interest rate is determined by the:
(A) intersection of the LM and IS curves.
(B) domestic rate of inflation.
(C) world rate of inflation.
(D) world interest rate.

Answer 5

(D) world interest rate.

Question 6

In a small open economy with perfect capital mobility, if the domestic interest rate were to rise above the world interest rate, then \_\_\_\_\_\_ would drive the domestic interest rate back to the level of the world interest rate.
(A) capital inflow
(B) capital outflow
(C) the central bank
(D) a decline in domestic saving

Answer 6

(A) capital inflow

Question 7

Assuming there is perfect capital mobility, compared to a large open economy, a small open economy is one in which the:
(A) exchange rate is fixed.
(B) exchange rate is floating.
(C) domestic interest rate equals the world interest rate.
(D) domestic interest rate is not equal to the world interest rate.

Answer 7

(C) domestic interest rate equals the world interest rate.

Question 8

In a small open economy, a decrease in its exchange rate will \_\_\_\_\_\_ net exports and shift the \_\_\_\_\_ curve.
(A) Increase; IS 
(B) decrease; IS 
(C) increase; LM 
(D) decrease; LM

Answer 8

(A) Increase; IS

Question 9

If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the IS* curve:
(A) slopes downward and to the right because the higher the exchange rate, the lower the level of net exports and, therefore, of short-run equilibrium income in the goods market.
(B) is vertical because there is only one investment level that is consistent with the world interest rate.
(C) is vertical because the exchange rate does not enter into the IS* equation.
(D) slopes downward and to the right because the higher the exchange rate, the higher the level of net exports and, therefore, of short-run equilibrium income in the goods market.

Answer 9

(A) slopes downward and to the right because the higher the exchange rate, the lower the level of net exports and, therefore, of short-run equilibrium income in the goods market.

Question 10

In the Mundell-Fleming model on a Y – e graph, the curves labeled IS* and LM* are labeled that way as a reminder that:

(A) the price level is held constant at the world price level p.
(B) the interest rate is held constant at the world interest rate r.
(C) the exchange rate is held constant at the world exchange rate e*.
(D) output is held constant at the full employment level.

Answer 10

(B) the interest rate is held constant at the world interest rate r*.

Question 11

If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the LM* curve:

(A) slopes upward and to the right because at a higher income a higher interest rate is needed to increase velocity.
(B) is vertical because monetary velocity is independent of the interest rate.
(C) is vertical because the exchange rate does not enter into the LM* equation.
(D) slopes upward and to the right because a higher exchange rate leads to a higher income.

Answer 11

(C) is vertical because the exchange rate does not enter into the LM* equation.

Question 12

In the Mundell-Fleming model, the exogenous variables are the:
(A) world interest rate, the price level, and the exchange rate.
(B) level of government spending, taxes, and income.
(C) exchange rate and level of income.
(D) price level, world interest rate, monetary policy, and fiscal policy

Answer 12

(D) price level, world interest rate, monetary policy, and fiscal policy

Question 13

The intersection of the IS* and LM* curves shows the \_\_\_\_\_\_ and the \_\_\_\_\_\_ at which both the goods market and the money market are in equilibrium.
(A) interest rate; price level
(B) price level; exchange rate 
(C) level of output; exchange rate 
(D) level of output; price level

Answer 13

(C) level of output; exchange rate

Question 14

Under a floating system, the exchange rate:
(A) fluctuates in response to changing economic conditions.
(B) is maintained at a predetermined level by the central bank.
(C) is changed at regular intervals by the central bank.
(D) fluctuates in response to changes in the price of gold.

Answer 14

(A) fluctuates in response to changing economic conditions.

Question 15

In a small open economy with a floating exchange rate, an effective policy to increase equilibrium output is to:
(A) increase government spending. 
(B) increase taxes.
(C) increase the money supply. 
(D) decrease the money supply.

Answer 15

(C) increase the money supply.

Question 16

In a small open economy with a floating exchange rate, an effective policy to decrease equilibrium output is to:
(A) decrease government spending. 
(B) decrease taxes.
(C) increase the money supply. 
(D) decrease the money supply.

Answer 16

(D) decrease the money supply.

Question 17

In a small open economy with a floating exchange rate, the exchange rate will appreciate if:
(A) The money supply is increased.
(B) the money supply is decreased. 
(C) government spending is decreased. 
(D) taxes are decreased.

Answer 17

(B) the money supply is decreased.

Question 18

In a small open economy with a floating exchange rate, the exchange rate will depreciate if:
(A) the money supply is decreased. 
(B) import quotas are imposed. 
(C) government spending is increased. 
(D) taxes are decreased

Answer 18

(D) taxes are decreased

Question 19

In a small open economy with a floating exchange rate, if the government adopts an expansionary fiscal policy, in the new short-run equilibrium:

(A) income and the exchange rate will both rise.
(B) the exchange rate will rise, but income will remain unchanged.
(C) income will rise, but the exchange rate will remain unchanged.
(D) both income and the interest rate will rise.

Answer 19

(B) the exchange rate will rise, but income will remain unchanged.

Question 20

-In a small open economy with a floating exchange rate, a rise in government spending in the new short-run equilibrium:
(A) chokes off investment, but not by as much as the new government spending.
(B) chokes off an amount of investment just equal to the new government spending.
(C) attracts foreign capital, thus raising the exchange rate and reducing net exports, but not by as much as the new government spending.
(D) attracts foreign capital, thus raising the exchange rate and reducing net exports by an amount just equal to the new government spending.

Answer 20

(D) attracts foreign capital, thus raising the exchange rate and reducing net exports by an amount just equal to the new government spending.

Question 21

In a small open economy with a floating exchange rate, the supply of real money balances is fixed and a rise in government spending:

(A) raises the interest rate, so that income must rise to maintain equilibrium in the money market.
(B) raises the interest rate so that net exports must fall to maintain equilibrium in the goods market.
(C) cannot change the interest rate so that net exports must fall to maintain equilibrium in the goods market.
(D) cannot change the interest rate so income must rise to maintain equilibrium in the money market.

Answer 21

(C) cannot change the interest rate so that net exports must fall to maintain equilibrium in the goods market.

Question 22

In a small open economy with a floating exchange rate, if the government decreases the money supply, then in the new short-run equilibrium:
(A) income falls and the exchange rate rises.
(B) the exchange rate falls and income rises.
(C) income remains unchanged but the exchange rate rises.
(D) the exchange rate remains unchanged but income falls.

Answer 22

(A) income falls and the exchange rate rises

Question 23

In a small open economy with a floating exchange rate, if the government increases the money supply, then in the new short-run equilibrium the:
(A) interest rate falls and the level of investment rises.
(B) exchange rate falls and net exports increase.
(C) interest rate falls but the level of investment does not rise.
(D) exchange rate falls but net exports do not increase.

Answer 23

(B) exchange rate falls and net exports increase.

Question 24

According to the Mundell-Fleming model for a small open economy with flexible exchange rates, if the Federal Reserve cannot alter domestic interest rates, changes in the money supply could still influence aggregate income through changes in the:
(A) exchange rate.
(B) price level.
(C) level of government spending. 
(D) tax rates.

Answer 24

(A) exchange rate.

Question 25

In a small open economy with a floating exchange rate, if the government imposes an import quota, then in the new short-run equilibrium the IS* curve shifts to the right, raising the exchange rate:
(A) but not raising net exports or income.
(B) and net exports but not income.
(C) and income but not net exports.
(D) net exports and income.

Answer 25

(A) but not raising net exports or income.

Question 26

In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium:
(A) imports will decrease while exports remain constant, leading to a rise in net exports.
(B) imports will decrease and exports will increase, leading to a rise in net exports.
(C) imports will decrease and exports will decrease by an equal amount.
(D) both imports and exports will remain unchanged.

Answer 26

(C) imports will decrease and exports will decrease by an equal amount.

Question 27

Questions 29/30 Graph Questions

Answer 27

Questions 29/30 Graph Questions

Question 28

Questions 29/30 Graph Questions

Answer 28

Questions 29/30 Graph Questions

Question 29

Under a fixed system, the exchange rate:
(A) fluctuates in response to changing economic conditions.
(B) is maintained at a predetermined level by the central bank.
(C) is changed at regular intervals by the central bank.
(D) fluctuates in response to changes in the price of gold.

Answer 29

(B) is maintained at a predetermined level by the central bank.

Question 30

To maintain a fixed-exchange-rate system, if the exchange rate moves below the fixed-exchange-rate level, then the central bank must:
(A) buy foreign currency.
(B) sell foreign currency from reserves.
(C) raise taxes.
(D) decrease government spending.

Answer 30

(B) sell foreign currency from reserves.

Question 31

If the Fed announced it would fix the exchange rate at 100 yen per dollar, but with the current money supply the equilibrium exchange rate was 150 yen per dollar, then:
(A) arbitrageurs would sell yen in the marketplace.
(B) arbitrageurs would buy yen from the Fed.
(C) the money supply would fall until the market exchange rate
(D) was 100 yen per dollar. the money supply would rise until the market exchange rate was 100 yen per dollar.

Answer 31

(D) was 100 yen per dollar. the money supply would rise until the market exchange rate was 100 yen per dollar.

Question 32

Under a fixed-exchange-rate system, the central bank of a small open economy must:
(A) have a reserve of its own currency, which it must have accumulated in past transactions.
(B) have a reserve of foreign currency, which it can print.
(C) allow the money supply to adjust to whatever level will ensure that the equilibrium exchange rate equals the announced exchange rate.
(D) follow a rule specifying a constant growth rate for the money supply.

Answer 32

(C) allow the money supply to adjust to whatever level will ensure that the equilibrium exchange rate equals the announced exchange rate.

Question 33

If there is a fixed-exchange-rate system, then in the short run described by the Mundell-Fleming model:
(A) the nominal exchange rate is fixed, but the real exchange rate is free to vary.
(B) the real exchange rate is fixed, but the nominal exchange rate is free to vary.
(C) both the nominal and real exchange rates are fixed.
(D) the nominal exchange rate is fixed, but whether the real exchange rate is fixed depends on whether the central bank follows a rule of constant growth of the money supply.

Answer 33

(C) both the nominal and real exchange rates are fixed.

Question 34

If there is a fixed-exchange-rate system, then in the long run:

a. the nominal exchange rate is fixed, but the real exchange rate is free to vary.
b. the real exchange rate is fixed, but the nominal exchange rate is free to vary.
c. both the nominal and real exchange rates are fixed.
d. the nominal and real exchange rates vary by a fixed amount.

Answer 34

a. the nominal exchange rate is fixed, but the real exchange rate is free to vary.

Question 35

During the era of the gold standard, the price of gold in England:
A. was always equal to the price of gold in the United States.
B. was always a little higher than the price of gold in the United States, but it could not be higher by more than the cost of transporting gold from the United States to England.
C. was always a little lower than the price of gold in the United States, but it could not be lower than the cost of transporting gold from England to the United States.
D. could be higher or lower than the price of gold in the United States, but not by more than the cost of transporting gold between the two countries.

Answer 35

D. could be higher or lower than the price of gold in the United States, but not by more than the cost of transporting gold between the two countries.

Question 36

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the new short-run equilibrium:
A. the exchange rate rises but income does not rise.
B. income rises but the exchange rate does not rise.
C. both income and the exchange rate rise.
D. neither income nor the exchange rate rises, as the money supply contracts.

Answer 36

B. income rises but the exchange rate does not rise.

Question 37

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the process of adjusting to the new short-run equilibrium, the money supply:
A. increases to keep the exchange rate unchanged, thus augmenting the effect of government spending on income.
B. decreases to keep the exchange rate unchanged, thus offsetting the effect of government spending on income.
C. remains unchanged, and there is no effect of government spending on income.
D. remains unchanged to keep the interest rate at the world interest, so that government spending reduces income.

Answer 37

A. increases to keep the exchange rate unchanged, thus augmenting the effect of government spending on income.

Question 38

In a small open economy with a fixed exchange rate, an effective policy to increase equilibrium output is to:
A. decrease government spending. 
B. decrease taxes.
C. increase the money supply. 
D. decrease the money supply.

Answer 38

B. decrease taxes.

Question 39

In a small open economy with a fixed exchange rate, if the central bank tries to increase the money supply, then in the new short-run equilibrium:
A. income rises.
B. income falls.
C. the exchange rate falls. 
D. income remains constant.

Answer 39

D. income remains constant.

Question 40

In a small open economy with a fixed exchange rate, if the country devalues its currency, then in the new short-run equilibrium the exchange rate \_\_\_\_\_\_, and the LM* curve shifts to the \_\_\_\_\_\_.
A. decreases; left 
B. increases; left 
C. decreases; right 
D. increases; right

Answer 40

C. decreases; right

Question 41

In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to decrease the money supply:
A. lead to a lower equilibrium level of income.
B. lead to a higher equilibrium level of income.
C. must be abandoned in order to maintain the fixed exchange rate.
D. must be offset by expansionary fiscal policy.

Answer 41

C. must be abandoned in order to maintain the fixed exchange rate.

Question 42

In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to increase the money supply lead the exchange rate to fall, giving arbitrageurs the incentive to ______ the central bank, which causes the money supply to ______.
A. sell domestic currency to; increase
B. sell domestic currency to; decrease
C. buy domestic currency from; increase D. buy domestic currency from; decrease

Answer 42

B. sell domestic currency to; decrease

Question 43

A revaluation of a currency under a fixed-exchange-rate system occurs when the level at which the currency is fixed is:
A. Increased. 
B. Decreased. 
C. Allowed to float. 
D. Kept Fixed with a band.

Answer 43

A. Increased.

Question 44

A devaluation of a currency under a fixed-exchange-rate system occurs when the level at which the currency is fixed is:
A. Increased. 
B. Decreased. 
C. Allowed to float. 
D. Kept Fixed with a band.

Answer 44

B. Decreased.

Question 45

During the Great Depression, countries that devalued their currencies generally ______ whereas countries that maintained the old exchange rate ______.
A. suffered longer; experienced no depression
B. recovered relatively quickly; experienced no depression
C. suffered longer; recovered relatively quickly
D. recovered relatively quickly; suffered longer

Answer 45

D. recovered relatively quickly; suffered longer

Question 46

In a small open economy with a fixed exchange rate, if the government imposes an import quota, then net exports:
A. decrease but the money supply falls and income falls.
B. increase, the money supply increases, and income increases.
C. are unchanged but the money supply falls and income falls.
D. are unchanged, the money supply is unchanged, and income is unchanged.

Answer 46

B. increase, the money supply increases, and income increases.

Question 47

In the Mundell-Fleming model with fixed exchange rates, the imposition of trade restrictions results in an increase in net exports because:
A. investment increases. B. investment decreases. C. saving increases.
D. saving decreases.

Answer 47

C. saving increases.

Question 48

According to the Mundell-Fleming model, under:
A. floating exchange rates, a monetary expansion raises income whereas a fiscal expansion does not, but under fixed exchange rates, a fiscal expansion raises income whereas a monetary expansion does not.
B. both floating and fixed exchange rates, a monetary expansion raises income, but a fiscal expansion does not.
C. both floating and fixed exchange rates, a fiscal expansion raises income, but a monetary expansion does not.
D. floating exchange rates, a fiscal expansion raises income whereas a monetary expansion does not; but under a fixed exchange rate, a monetary expansion raises income whereas a fiscal expansion does not.

Answer 48

A. floating exchange rates, a monetary expansion raises income whereas a fiscal expansion does not, but under fixed exchange rates, a fiscal expansion raises income whereas a monetary expansion does not.

Question 49

According to the Mundell-Fleming model, under floating exchange rates a fiscal expansion:
A. lowers the exchange rate, but a monetary expansion raises it.
B. raises the exchange rate, but a monetary expansion or an import restriction lowers it.
C. or an import restriction lowers the exchange rate, but a monetary expansion raises it.
D. or an import restriction raises the exchange rate, but a monetary expansion lowers it.

Answer 49

D. or an import restriction raises the exchange rate, but a monetary expansion lowers it.

Question 50

According to the Mundell-Fleming model, under fixed exchange rates expansionary fiscal policy causes income to \_\_\_\_\_\_, and under flexible exchange rates expansionary fiscal policy causes income to \_\_\_\_\_\_.
A. increase; increase
B. increase; remain unchanged
C, remain unchanged; remain unchanged 
D. remain unchanged; increase

Answer 50

B. increase; remain unchanged

Question 51

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes the exchange rate to \_\_\_\_\_\_ and expansionary monetary policy causes the exchange rate to \_\_\_\_\_\_.
A. rise; rise 
B. rise; fall 
C. fall; fall
D. fall; rise

Answer 51

B. rise; fall

Question 52

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes net exports to \_\_\_\_\_\_ and expansionary monetary policy causes net exports to \_\_\_\_\_\_.
A. increase; increase 
B. increase; decrease 
C. decrease; decrease
D. decrease; increase

Answer 52

D. decrease; increase

Question 53

According to the Mundell-Fleming model, import restrictions in an economy with flexible exchange rates cause net exports to \_\_\_\_\_\_ and in an economy with fixed exchange rates import restrictions cause net exports to \_\_\_\_\_\_.
A. increase; increase
B. increase; remain unchanged
C. remain unchanged; remain unchanged 
D. remain unchanged; increase

Answer 53

D. remain unchanged; increase

Question 54

According to the Mundell-Fleming model, under flexible exchange rates expansionary monetary policy \_\_\_\_\_\_ increase income and under fixed exchange rates expansionary monetary policy \_\_\_\_\_\_ increase income
A. can; can
B. can; cannot 
C. cannot; can 
D. cannot; cannot

Answer 54

B. can; cannot

Question 55

The risk premium included in the interest rate of small open economies incorporates:
A. country risk and expectations of future exchange-rate changes. B. the law of one price.
C. inefficient activity by arbitrageurs.
D. capital mobility.

Answer 55

A. country risk and expectations of future exchange-rate changes.

Question 56

Country risk included in the risk premium in interest rates refers to the:
A. additional costs incurred when loans are made in currencies other than the domestic currency.
B. possibility that loans in some countries may not be repaid because of political upheaval.
C. expectation that the exchange rate may change in the future.
D. potential change in the terms of trade between countries.

Answer 56

B. possibility that loans in some countries may not be repaid because of political upheaval.

Question 57

In order to compensate for an expected future decline in the Japanese yen relative to the U.S. dollar, the interest rate in Japan must be \_\_\_\_\_\_ the interest rate in the  United States.
A.higher than
B. lower than 
C. equal to
D. fixed relative to

Answer 57

A.higher than

Question 58

In the Mundell-Fleming model, if political turmoil raises the risk premium in a country’s interest rate, then the exchange rate will:
A. increase.
B. decrease.
C. remain constant.
D. either increase or decrease, depending on whether the IS* or LM* curve shifts more.

Answer 58

B. decrease.

Question 59

In the Mundell-Fleming model, expectations that a currency will lose value in the future will cause the current exchange rate to:
A. increase in the present. 
B. decrease in the present. 
C. remain constant in the present. 
D. decrease only in the future.

Answer 59

B. decrease in the present.

Question 60

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) ______ sufficient to offset the decline in the demand for money caused by the higher risk premium.
A. decrease in the money supply
B. increase in the money supply
C. decrease in government spending D. fall in the price level

Answer 60

A. decrease in the money supply

Question 61

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) ______ sufficient to offset the decline in the demand for money caused by the higher risk premium.
A. Increase in the money supply
B. decrease in government spending
C. increase in the price level caused by more expensive imports
D. fall in the price level caused by less expensive imports

Answer 61

C. increase in the price level caused by more expensive imports

Question 62

According to the Mundell-Fleming model with floating exchange rates, political uncertainty in Mexico in 1994 caused the risk premium on Mexican interest rates to \_\_\_\_\_\_ and the Mexican exchange rate to \_\_\_\_\_\_.
A. increase; increase 
B. increase; decrease 
C. decrease; increase 
D. decrease; decrease

Answer 62

B. increase; decrease

Question 63

At the end of 1994 the Mexican government was unable to maintain a fixed exchange rate because it:
A. ran out of foreign-currency reserves.
B. was unable to increase the supply of Mexican pesos.
C. was forced by the IMF to let the peso float.
D. joined an exchange-rate union.

Answer 63

A. ran out of foreign-currency reserves.

Question 64

“Crony capitalism” refers to situations in which banks make loans to those borrowers with the most:
A. profitable investment projects. 
B. political clout.
C. ability to repay the loans. 
D. creditworthy borrowers.

Answer 64

B. political clout.

Question 65

One argument favoring a floating-exchange-rate system is that it:
A. makes international trade less difficult.
B. minimizes destabilizing speculation by international investors.
C. allows monetary policy to be used for other purposes.
D. helps prevent excessive growth in the money supply.

Answer 65

C. allows monetary policy to be used for other purposes.

Question 66

One argument favoring a fixed-exchange-rate system is that it:
One argument favoring a fixed-exchange-rate system is that it:
A. allows monetary policy to be used for stabilizing output and prices.
B. reduces exchange-rate uncertainty, thereby promoting more international trade.
C. leads to excessive growth of the money supply.
D. requires no actions on the part of the central bank to implement.

Answer 66

B. reduces exchange-rate uncertainty, thereby promoting more international trade.

Question 67

A monetary union with a common currency is an example of a:
A. fixed-exchange-rate system. 
B. flexible-exchange-rate system. 
C. small open economy.
D. large open economy.

Answer 67

A. fixed-exchange-rate system.

Question 68

Some economists argue that monetary union will not work as well in Europe as it does in the United States for all of the following reasons except:
A. labor is not as mobile in Europe as it is in the United States.
B. there is no strong central government that can use fiscal policy in Europe as there is in the United States.
C. there is no common language in Europe as there is in the United States.
D. there is no European central bank as there is in the United States.

Answer 68

D. there is no European central bank as there is in the United States.

Question 69

If the exchange rate of currency A is fixed to a unit of currency B, then a potential problem for the central bank in charge of currency A is:
A. running out of currency A.
B. running out of currency B.
C. generating excessive revenue from seigniorage.
D. ineffective fiscal policy.

Answer 69

B. running out of currency B.

Question 70

A speculative attack on a currency occurs when:
A. a central bank switches from a floating to a fixed exchange rate.
B. investors’ perceptions change, making a fixed exchange rate untenable.
C. a country accepts dollarization.
D. a central bank adopts a currency board to back the domestic currency with a foreign currency.

Answer 70

B. investors’ perceptions change, making a fixed exchange rate untenable.

Question 71

A change in investors’ perceptions that make a fixed exchange rate untenable is known as:
A. a speculative attack. B. dollarization.
C. seigniorage.
D. a floating currency board.

Answer 71

A. a speculative attack.

Question 72

An arrangement by which a central bank holds enough foreign currency to back each unit of the domestic currency is called a:
A. floating exchange rate. B. dollarization.
C. monetization.
D. currency board.

Answer 72

D. currency board.

Question 73

When a country abandons its national currency and adopts the currency of the United States, this is known as:
A. a floating-exchange-rate system.
B. dollarization.
C. a speculative attack on the United States.
D. a currency board.

Answer 73

B. dollarization.

Question 74

The principal economic loss when a country dollarizes is the loss of:
A. seigniorage revenue.
B. income tax revenue.
C. monetary stability.
D. a fixed exchange rate with the dollar.

Answer 74

A. seigniorage revenue.

Question 75

The “impossible trinity” refers to the idea that it is impossible for a country to simultaneously have:
A. low inflation, low unemployment, and a rapid rate of GDP growth.
B. free capital flows, a fixed exchange rate, and an independent monetary policy.
C. high interest rates, a budget deficit, and a trade deficit.
D. an expansionary fiscal policy, a contractionary monetary policy, and a flexible exchange rate.

Answer 75

B. free capital flows, a fixed exchange rate, and an independent monetary policy.

Question 76

If a country chooses to have free capital flows and to conduct an independent monetary policy, then it must:
A. live with exchange-rate volatility.
B. restrict its citizens from participating in world financial markets.
C. give up the use of monetary policy for purposes of domestic stabilization.
D. have a fixed exchange rate.

Answer 76

A. live with exchange-rate volatility.

Question 77

If a country chooses to have free capital flows and to maintain a fixed exchange rate, then it must:
A. live with exchange-rate volatility.
B. restrict its citizens from participating in world financial markets.
C. give up the use of monetary policy for purposes of domestic stabilization.
D. give up the use of fiscal policy for purposes of domestic stabilization.

Answer 77

C. give up the use of monetary policy for purposes of domestic stabilization.

Question 78

If a country chooses to restrict international capital flows and to maintain a fixed exchange rate, then it must:
A. live with exchange-rate volatility.
B. control its citizen’s access to world financial markets.
C. give up the use of monetary policy for purposes of domestic stabilization.
D. give up the use of fiscal policy for purposes of domestic stabilization.

Answer 78

B. control its citizen’s access to world financial markets.

Question 79

Which of the following would be evidence that a country with a fixed exchange rate has an undervalued currency?
A. The government has a budget surplus.
B. The government has a budget deficit.
C. The central bank’s foreign-currency reserves are increasing. D. The central bank’s foreign-currency reserves are decreasing.

Answer 79

C. The central bank’s foreign-currency reserves are increasing.

Question 80

Between 1995 and 2005, China chose to:
A. conduct independent monetary policy, allow free international-capital flows, and maintain a fixed exchange rate.
B. maintain a fixed exchange rate, allow free international-capital flows, and give up the use of monetary policy for domestic stabilization.
C. conduct an independent monetary policy, restrict international-capital flows, and maintain a fixed exchange rate.
D. allow a flexible exchange rate, conduct an independent monetary policy, and allow free international- capital flows.

Answer 80

C. conduct an independent monetary policy, restrict international-capital flows, and maintain a fixed exchange rate.

Question 81

In the Mundell-Fleming model, if the price level falls, then the equilibrium income
A. rises and the real exchange rate appreciates.
B. rises and the real exchange rate depreciates.
C. falls and the real exchange rate appreciates.
D. falls and the real exchange rate depreciates.

Answer 81

B. rises and the real exchange rate depreciates.

Question 82

In the Mundell-Fleming model, if the economy is operating at or below the natural level in the short run, then in the long run the price level will fall, the exchange rate will ______, and net exports will ______ to restore the economy to its natural rate.
A. appreciate; increase B. appreciate; decrease C. depreciate; increase D. depreciate; decrease

Answer 82

C. depreciate; increase

Question 83

In the Mundell-Fleming model with flexible exchange rates, an increase in the price level results in a(n) ______ in the real exchange rate and a(n) ______ in net exports.
A. increase; increase
B. increase; decrease
C. decrease; decrease D. decrease; increase

Answer 83

B. increase; decrease

Question 84

In a large open economy with a floating exchange rate, such as in the United States, in the short run a monetary contraction:
A. raises the interest rate, lowers investment and income, but does not affect the exchange rate.
B. raises the exchange rate, lowers net exports and income, but does not affect the interest rate.
C. initially raises the exchange rate, causing arbitrageurs to sell dollars and return the money supply to its initial level.
D. raises the interest rate and lowers investment and income, but also raises the exchange rate and lowers net exports

Answer 84

D. raises the interest rate and lowers investment and income, but also raises the exchange rate and lowers net exports

Question 85

In a short-run model of a large open economy with a floating exchange rate, net capital outflow \_\_\_\_\_\_ as the domestic interest rate increases and is just equal to \_\_\_\_\_\_.
A. decreases; minus net exports 
B. decreases; net exports 
C. increases; minus net exports 
D. increases; net exports

Answer 85

B. decreases; net exports

Question 86

In a short-run model of a large open economy, after net capital outflow is substituted for net exports in the IS curve:
A. the larger the absolute value of the responsiveness of net capital outflow with respect to the interest rate, the flatter the IS curve.
B. the larger the absolute value of the responsiveness of net capital outflow with respect to the interest rate, the steeper the IS curve.
C. if both domestic investment and net capital outflow are very responsive to the interest rate, they will tend to cancel each other out.
D. the slope of the IS curve depends only on the interest responsiveness of investment and the marginal propensity to consume.

Answer 86

A. the larger the absolute value of the responsiveness of net capital outflow with respect to the interest rate, the flatter the IS curve.

Question 87

In a short-run model of a large open economy with a floating exchange rate:
A. net exports determine the exchange rate, which in turn determines net capital outflow.
B. net exports determine net capital outflow, which determines the interest rate.
C. the interest rate is determined in the IS–LM framework, and this value determines net capital outflow; then the exchange rate adjusts to make net exports equal net capital outflow.
D. the interest rate determines investment and net capital outflow, which are equal within the IS–LM framework; the exchange rate then determines net exports.

Answer 87

C. the interest rate is determined in the IS–LM framework, and this value determines net capital outflow; then the exchange rate adjusts to make net exports equal net capital outflow.

Question 88

In a short-run model of a large open economy with a floating exchange rate, a fiscal expansion causes an increase in:
A. the exchange rate and a fall in net exports but has no effect on income.
B. the money supply and an increase in income but has no effect on the exchange rate.
C. income, the interest rate, and net exports, but a decrease in investment and in the exchange rate.
D. income, the interest rate, and the exchange rate, but a decrease in investment and net exports

Answer 88

D. income, the interest rate, and the exchange rate, but a decrease in investment and net exports

Question 89

In a short-run model of a large open economy with a floating exchange rate, a monetary expansion causes a decrease in the interest rate and:
A. the exchange rate but has no effect on income.
B. the exchange rate, and increases in income, net capital outflow, and net exports.
C. the exchange rate and net capital outflow, and increases in income and net exports.
D. net exports and net capital outflow, but increases in investment and income.

Answer 89

B. the exchange rate, and increases in income, net capital outflow, and net exports.

Question 90

A fall in consumer confidence about the future, which induces consumers to spend less and save more, will, according to the Mundell-Fleming model with floating exchange rates, lead to:
A. a fall in consumption and income.
B. no change in consumption or income.
C. no change in income but a rise in net exports. D. no change in income or net exports.

Answer 90

C. no change in income but a rise in net exports.

Question 91

A fall in consumer confidence about the future, which induces consumers to spend less and save more, will, according to the Mundell-Fleming model, with fixed exchange rates, lead to:
A. a fall in consumption and income.
B. no change in consumption or income.
C. no change in income but a rise in net exports. D. a fall in income but a rise in net exports.

Answer 91

A. a fall in consumption and income.

Question 92

The introduction of a stylish new line of Toyotas, which makes some consumers prefer foreign cars over domestic cars, will, according to the Mundell-Fleming model with floating exchange rates, lead to:
A. a fall in income and net exports.
B. no change in income or net exports.
C. a fall in income but no change in net exports. D. no change in income but a fall in net exports.

Answer 92

B. no change in income or net exports.

Question 93

The introduction of a stylish new line of Toyotas, which makes some consumers prefer foreign cars over domestic cars, will, according to the Mundell-Fleming model with fixed exchange rates, lead to:
A. a fall in income and net exports.
B. no change in income or net exports.
C. a fall in income but no change in net exports. D. no change in income but a fall in net exports.

Answer 93

A. a fall in income and net exports.

Question 94

he introduction of automatic teller machines, which reduces the demand for money, will, according to the Mundell- Fleming model with floating exchange rates, lead to:
A. no change in income and net exports.
B. no change in income but a rise in net exports. C. a rise in income but no change in net exports.
D. a rise in both income and net exports.

Answer 94

D. a rise in both income and net exports.

Question 95

The introduction of automatic teller machines, which reduces the demand for money, will, according to the Mundell- Fleming model with fixed exchange rates, lead to:
a rise in income and net exports.
A. no change in income or net exports.
B. no change in income but a rise in net exports. C. a rise in income but D. no change in net exports.

Answer 95

B. no change in income but a rise in net exports.

Question 96

In the Mundell-Fleming model with a floating exchange rate, a rise in the world interest rate will lead income:
A. and net exports both to fall. 
B. to rise and net exports to fall. 
C. to fall and net exports to rise. 
D. and net exports both to rise.

Answer 96

D. and net exports both to rise.

Question 97

In the Mundell-Fleming model with a fixed exchange rate, a rise in the world interest rate will lead income:
A. and net exports both to fall.
B. to fall while net exports are unchanged. C. to be unchanged and net exports to fall.
D. and net exports to both be unchanged.

Answer 97

B. to fall while net exports are unchanged.

Question 98

The goods produced in U.S. industry may be made more competitive in world markets by:
A. appreciating the U.S. currency.
B. depreciating the U.S. currency.
C. keeping the exchange rate fixed. D. expanding the money supply.

Answer 98

B. depreciating the U.S. currency.

Question 99

If investors in a large open economy become more willing to substitute foreign and domestic assets, then this will make the net capital outflow function:
A. steeper, and the slope of the IS curve steeper.
B. steeper, and the slope of the IS curve flatter.
C. flatter, and the slope of the IS curve steeper. D. flatter, and the slope of the IS curve flatter.

Answer 99

D. flatter, and the slope of the IS curve flatter.

Question 100

BONUS Which questions are questions that required a graph from the test banks?

Answer 100

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