Midterm 2

Question 1

What does it mean when a floating exchange rate system is “pure”?

Answer 1

no intervention whatsoever

Question 2

What does it mean when a floating exchange rate system is “dirty”?

Answer 2

intervention to eliminate abnormal exchange rate fluctuations

Question 3

T or F. Considering the fiscal multiplier, all we need is ΔG and ΔY. Why?

Answer 3

False, that would suppose that everything else remains the same, which is never the case

Question 4

What can Congress do that Treasury can’t?

Answer 4

Enact mandatory budget items so only Congress can revoke

Question 5

What is fiscal voracity?

Answer 5

it is when governments almost always strive for additional spending, followed by increased tax pressure and government borrowing

Question 6

What is formula for gross financing needs?

Answer 6

Overall balance + Maturing debt

Question 7

What affects the fiscal multiplier?

Answer 7

1) marginal propensity to consume
2) marginal propensity to invest
3) negative marginal propensity to import
4) the degree of Ricardian Equivalence
5) stronger automatic stabilizers
6) output gap
7) initial level of public debt and sovereign spread before fiscal expansion

Question 8

What is expansionary fiscal adjustment?

Answer 8

When a reduction in government spending results in GDP growth

Question 9

High GDP per capita countries have ______ levels of public spending to GDP, and vice versa.

Answer 9

low

Question 10

Why do fiscal adjustments exist?

Answer 10

born out of a necessity to restore budgetary balance as a result of a lack of access to credit

Question 11

Considering “G” from national accounts, what does it not include?

Answer 11

1) social security
2) transfer and other social redistribution programs
3) interest payments
4) government investment in infrastructure

Question 12

Considering “G” from national accounts, what is it comprised of?

Answer 12

spending that implies additional production, such as government wages

Question 13

What is the main difference between overall balance and primary balance?

Answer 13

interest payments

Question 14

T or F. If the public debt is negative, then the primary fiscal balance is greater than the overall fiscal balance.

Answer 14

False, overall balance would be greater than primary fiscal balance

Question 15

T or F. If the public debt is positive, then the primary fiscal balance is greater than the overall fiscal balance.

Answer 15

True

Question 16

T or F. All advanced countries follow countercyclical fiscal policies and all emerging and developing countries follow procyclical policies

Answer 16

False because there is no clear pattern across the globe.

Question 17

The fiscal multiplier is expected to be higher under a recession if compared to when the economy is going an expansion.

Answer 17

True

Question 18

The employment rate is countercyclical (read this carefully!)

Answer 18

False

Question 19

Suppose the fiscal multiplier is equal to 5. If the income tax rate is 50%, does a fiscal expansion pay for itself?

Answer 19

True

Question 20

A decrease in both the marginal propensity to consume and the marginal propensity to import would increase the fiscal multiplier

Answer 20

False

Question 21

If Ricardian Equivalence holds, then it must be the case that the fiscal multiplier is small.

Answer 21

True

Question 22

The fact that the long run fiscal multiplier is empirically estimated to be between 0.6-1.0 implies that fiscal policy is ineffective.

Answer 22

False

Question 23

If the fiscal multiplier is positive and greater than zero, it can be argued that a financial adjustment can lead to a decrease in the GDP.

Answer 23

True

Question 24

Countercyclical fiscal policy increases the volatility of GDP.

Answer 24

False

Question 25

A progressive income tax system is an example of an automatic stabilizer.

Answer 25

True

Question 26

If we have a positive output gap, it must be the case that the potential GDP is higher than actual GDP.

Answer 26

False

Question 27

Assume a real exchange rate devaluation leads to net exports increasing by 10%, with all else equal. This is an example of an expansionary devaluation.

Answer 27

True; A real exchange rate devaluation that leads to an increase in Y = (C + I + G +
NX) is an example of an expansionary devaluation.

Question 28

If the international price of a good is higher than its domestic price, then the good is an importable good.

Answer 28

False; If the international price is higher than the domestic price for a tradable good, then when the market opens the domestic supply of the good is higher than the domestic demand meaning that the suppliers of the good will sell it on the international martket.

Question 29

If the exchange rate is fixed above the floating exchange rate, then the central bank will run out of international reserves.

Answer 29

False; If the exchange rate is above the floating, then, the central bank will be accumulating international reserves so it will not run out of them

Question 30

The elasticities approach would indicate that when the real exchange rate increases exports should increase and imports should decrease.

Answer 30

True; Real exchange rate going up is a devaluation of the local currency. It makes it cheaper to export, and more expensive to import.

Question 31

The elasticities approach would indicate that when foreign income increases exports should increase and imports should decrease.

Answer 31

False; The first half of the statement is true, exports should increase. However, foreign income should not affect imports, only domestic income

Question 32

In an exchange rate system with bands (also called a currency band), the central bank will not buy or sell foreign currency as long as the market-determined exchange rate does not fall below the lower band (floor) or pierces the upper limit (ceiling).

Answer 32

True; By definition of how this system works.

Question 33

If labor is a non-tradeable service, that means that a nominal devaluation, all else equal, will make workers worse off. The situation would be even worse for those workers that owe debts denominated in foreign currency

Answer 33

True; A devaluation makes tradable goods more expensive (including fuel, food and other household goods), but should not affect wages, as labor is mostly non-tradable, so the wage purchasing power must drop as a result

Question 34

Assume that the price of tradables and non-tradable goods are the same, then in this case the real exchange rate is equal to 1.

Answer 34

True; By one of the definitions of the real exchange rate, it is equal to (Tradable Prices) / (Non-Tradeable Prices)

Question 35

The real exchange rate between the US and China can be defined in either Dollars/Yuan or Yuan/Dollars

Answer 35

False; The real exchange rate is unitless.

Question 36

Suppose that the MPC is 0.2, the Marginal Propensity to Import is 0.3 and the Marginal Propensity to Invest is 0.1. The multiplier is 4.

Answer 36

False; This follows from the multiplier equations (1) / (1 − c1 − i1 + m1)

Question 37

Countercyclical fiscal policy involves the government reducing its spending during economic downturns and increasing it during periods of growth.

Answer 37

False; In contrast, countercyclical fiscal policy should increase spending in bad times to stimulate the economy and decreases it in good times to prevent overheating

Question 38

It is true that a current account deficit invariably results in a decrease in a country’s international reserves.

Answer 38

False; International reserves are kept by the central bank, so the current account deficit has no effect on it directly.

Question 39

The variation in international reserves is, as adjusted by the Central Bank, considered a component of the supply side in the foreign exchange market.

Answer 39

False; The supply function in the foreign exchange market typically pertains to how much foreign currency is available for sale from private entities, such as businesses, investors, and individuals. The Central Bank’s adjustments to international reserves are separate actions that influence the overall balance of the foreign exchange market but are not a direct part of the supply curve that one would study in a basic supply and demand model.

Question 40

The implied Purchasing Power Parity (PPP) conversion rate is lower than the actual market exchange rate.

Answer 40

False; It depends on the country (excluding the US, since it’s often used as the base).

Question 41

Small open economies accept the international pricing of exports and imports as fixed, without impacting these prices, whereas large economies have the autonomy to set the prices for their exports and imports

Answer 41

False; In reality, while small open economies may have limited influence on international prices due to their smaller economic scale, they are not entirely without influence; their collective actions can impact market conditions.

Question 42

Empirically, a more substantial governmental presence necessarily leads to increased taxation on the private sector, subsequently causing diminished investment, economic growth, and GDP per capita.

Answer 42

False; A larger government sector can lead to higher taxes, but this does not universally translate to reduced investment or growth.

Question 43

If the output gap is positive, then actual GDP exceeds potential GDP.

Answer 43

True; An output gap measures the difference between a country’s actual economic output (GDP) and its potential output at full capacity or full employment. When the output gap is zero, it indicates that the economy is producing at its full potential, and there is neither a surplus nor a deficit in economic activity relative to the economy’s potential. In other words, the actual GDP and potential GDP are equal.

Question 44

Counter-cyclical fiscal policies, which include reducing taxes or increasing government spending during a downturn, are designed to directly boost consumer spending and aggregate demand.

Answer 44

True; During a recession, which is characterized by reduced economic activity, these policies typically involve tax cuts or increased government expenditure, which are considered as fiscal expansion.

Question 45

Both developed and developing countries have non-tradable goods, which are products and services that must be consumed where they are produced.

Answer 45

True; Example: every country has a labor force which is non-tradable.

Question 46

Stable prices for international commodities like metals, grains, and oil would generally indicate that global supply and demand for these commodities are also stable.

Answer 46

True; Price stability in commodities usually reflects a balance between supply and de-
mand. Sudden changes in either can disrupt this balance, leading to price fluctuations. On the contrast, if these commodities are volatile, the world supply/demand must also be volatile.

Question 47

The discrepancy between the theoretical zero-sum nature of global current account balances and the non-zero outcomes observed in practice can often be attributed to errors and omissions in the recording of international transactions.

Answer 47

True; Discrepancies arise due to the practical challenges of accurately recording all international transactions, which may include under-the-table dealings, mistakes in record keeping , or difficulties in tracking all financial flows.

Question 48

If international shipping and other associated costs are nonexistent and all goods that can be exported or imported are priced in US dollars internationally, then a nominal exchange rate of 1.5 between the euro and the dollar would imply that local prices in the Euro Zone for these goods will be 1.5 times the international dollar price.

Answer 48

True; For example, if a commodity is priced at $100 on the international market, it would be sold for €150 in the Euro Zone under this new exchange rate. The ”1.5 times” factor directly reflects the exchange rate: for every dollar of the international price, you need 1.5 euros to match it because of the 1.5:1 exchange rate.

Question 49

The concept of Ricardian Equivalence differs from automatic stabilizers as it pertains to the theory that consumers anticipate future taxation and adjust their spending accordingly

Answer 49

True; Automatic stabilizers are built-in economic policies and regulations that automatically adjust with the economic cycle without the need for explicit government intervention, while Ricardian Equivalence suggests that government deficit spending will not affect the overall level of demand in an economy. It is based on the premise that when a government increases deficit spending, consumers anticipate future tax increases to pay off the debt.

Question 50

What are fiscal adjustments?

Answer 50

are reductions in fiscal deficit through either less government spending or more taxation