CHAPTER 22

Internal and External Balance with Fixed Exchange Rates

 

Multiple Choice Questions

 

1.         Which of the following are domestic assets?

 

            (1)        debt securities

            (2)        loans to banks

            (3)        foreign currency assets

            (4)        currency

            (5)        deposits to the central bank from banks

 

a.   (1) + (2) + (3)

b.   (1) + (2) + (3) + (4) + (5)

c.   (1) + (2)

d.   (1)

            ANSWER:       C

 

2.         The combination of currency and deposits to the central bank from commercial banks is called:

a.   the money supply.

b.   domestic assets.

c.   the monetary base.

d.   international reserve assets.

            ANSWER:       C

 

3.         Which of the following consists mainly of currency held by the public and various types of deposits that the public has at banks?

a.   the money supply.

b.   domestic assets.

c.   the monetary base.

d.   international reserve assets.

            ANSWER:       A

 

4.         The expansion of the money supply through a fractional reserve banking system is called:

a.   the money multiplier process.

b.   the monetary base.

c.   international reserve assets.

d.   domestic assets.

            ANSWER:       A

 

5.         If a country has an official settlements balance surplus so that the exchange rate value of the country¡¯s currency is experiencing upward pressure,:

           

            (1)        the central bank must intervene to buy foreign currency and sell domestic currency.

            (2)        its balance sheet will show an increase in official international reserve holdings.

            (3)        its balance sheet will show an increase in its liabilities.

 

a.   (1)

b.   (1) + (2)

c.   (1) + (2) + (3)

d.   (2) + (3)

            ANSWER:       C

 

6.         _______ the money supply _______ the Balance of Payments with fixed exchange rates.

a.   Contracting; worsens

b.   Expanding; worsens

c.   Expanding; improves

d.   None of the above.

            ANSWER:       B

 

7.         Which of the following is taking an action to reverse the effect of official intervention on the domestic money supply.

a.   a domestic monetary shock

b.   a domestic spending shock

c.   an international trade shock

d.   sterilization

            ANSWER:       D

 

8.         Which of the following statements is accurate?

 

(1)        Fixed exchange rates greatly constrain a country¡¯s ability to pursue an independent monetary policy.

(2)        Fiscal policy is highly effective with fixed exchange rates in an environment of highly responsive international capital flows.

(3)        Fiscal policy is effective with fixed exchange rates and unresponsive international capital flows.

 

a.   (1) + (2)

b.   (1) + (2) + (3)

c.   (2) + (3)

d.   (1) + (3)

            ANSWER:       A

 

 

 

9.         Which of the following means that international capital flows will be highly responsive to the slightest change in a country¡¯s interest rates?

a.   a domestic monetary shock

b.   perfect capital mobility

c.   an international capital-flow shock

d.   sterilization

            ANSWER:       B

 

10.       Which of the following is true with perfect capital mobility?

           

(1)        Monetary policy is impotent with fixed exchange rates and perfect capital mobility.

            (2)        With perfect capital mobility, the LM curve and FE curve coincide.

            (3)        With perfect capital mobility, the IS curve is a horizontal line.

            (4)        Fiscal policy is very strong with perfect capital mobility.

 

a.   (1) + (2) + (3)

b.   (2) + (3) + (4)

c.   (1) + (2) + (4)

d.   (1) + (3) + (4)

            ANSWER:       C

 

11.       Which of the following alters the equilibrium relationship between the money supply and money demand?

a.   a domestic monetary shock

b.   a domestic spending shock

c.   an international capital-flow shock

d.   an international trade shock

            ANSWER:       A

 

12.       Which of the following alters real expenditure in a country through an exogenous force that alters consumption or investment or government spending?

a.   a domestic monetary shock

b.   a domestic spending shock

c.   an international capital-flow shock

d.   an international trade shock

            ANSWER:       B

 

13.       Which of the following is the unpredictable shift of internationally mobile funds in response to rumors about political changes or capital controls?

a.   a domestic monetary shock

b.   a domestic spending shock

c.   an international capital-flow shock

d.   an international trade shock

            ANSWER:       C

 

14.       Which of the following is a shift in a country¡¯s exports or imports that arises from causes other than changes in the real income of the country?

a.   a domestic monetary shock

b.   a domestic spending shock

c.   an international capital-flow shock

d.   an international trade shock

ANSWER:       D

 

15.       Which of the following policies alone is appropriate for a country with high unemployment, a balance of payments surplus, and fixed exchange rates?

a.   expansionary fiscal policy

b.   expansionary monetary policy

c.   contractionary fiscal policy

d.   uncertain

            ANSWER:       A

 

16.       Which of the following policies alone is appropriate for a country with high inflation, a balance of payments deficit, and fixed exchange rates?

a.   expansionary fiscal policy

b.   expansionary monetary policy

c.   contractionary fiscal policy

d.   uncertain

            ANSWER:       C

 

17.       Which of the following policies alone is appropriate for a country with high inflation, a balance of payments surplus, and fixed exchange rates?

a.   expansionary fiscal policy

b.   expansionary monetary policy

c.   contractionary fiscal policy

d.   uncertain

            ANSWER:       D

 

18.       Which of the following policies alone is appropriate for a country with high unemployment, a balance of payments deficit, and fixed exchange rates?

a.   expansionary fiscal policy

b.   expansionary monetary policy

c.   contractionary fiscal policy

d.   uncertain

            ANSWER:       D

 

19.       To which of the following economists is the assignment rule attributed?

a.   Adam Smith

b.   Paul Samuelson

c.   Robert Mundell

d.   Bertil Ohlin

            ANSWER:       C

 

20.       Which of the following involves using fiscal policy to stabilize the domestic economy and monetary policy to stabilize the balance of payments?

a.   sterilization

b.   the IS-LM-FE framework

c.   the assignment rule

d.   perfect capital mobility

            ANSWER:       C

 

21.       Based on the assignment rule, which of the following is not an appropriate policy response?

a.   A country with a fixed exchange rate has high unemployment and a balance of payments surplus. The country should ease both monetary policy and fiscal policy.

b.   A country with a fixed exchange rate has high unemployment and a balance of payments deficit. The country should tighten monetary policy and ease fiscal policy.

c.   A country with a fixed exchange rate has high levels of inflation and a balance of payments surplus. The country should ease both monetary policy and fiscal policy.

d.   A country with a fixed exchange rate has high levels of inflation and a balance of payments deficit. The country should tighten both monetary policy and fiscal policy.

            ANSWER:       C

 

22.       Which of the following illustrates the response of a country¡¯s trade balance to a drop in the exchange rate value of the country¡¯s currency?

a.   IS curve

b.   LM curve

c.   FE curve

d.   J curve

            ANSWER:       D

 


True/False Questions

 

23.       The assignment rule says that, with fixed exchange rates, fiscal policy should be assigned to stabilizing the balance of payments and monetary policy should be assigned to stabilizing the domestic economy.

            ANSWER:       False

 

24.       Perfect capital mobility with fixed exchange rates makes fiscal policy ineffective in influencing domestic interest rates.

            ANSWER:       False

 

25.       With perfect capital mobility, the LM and FE curves are both horizontal.

            ANSWER:       True

 

26.       A central bank can sterilized the increase in the money supply that results from an intervention to defend a fixed exchange rate by selling domestic government bonds.

            ANSWER:       True

 

27.       With fixed exchange rates, external capital flow shocks have little impact on internal balance, but an international trade shock will have a powerful impact on the internal balance of the country.

            ANSWER:       False

 

28.       The J curve shows a typical response of the current account balance to a drop in the exchange rate value of a country¡¯s currency.

            ANSWER:       True

 

29.       According to the assignment rule, if a country has rapid inflation and a balance of payments surplus, it should ease monetary policy and tighten fiscal policy.

            ANSWER:       True

 

30.       An international capital-flow shock is a shift in a country¡¯s net exports that arises from causes other than changes in the real income of the country.

            ANSWER:       False

 

31.       The multiple expansion of the money supply with the fractional reserve banks system is called sterilization.

            ANSWER:       False

 

32.       Currency and deposits from commercial banks at the central bank are called the money supply.

            ANSWER:       False


Essay Questions

 

33.       Explain how a central bank might sterilize.

 

34.      Explain the effects of expanding the money supply on the balance of payments of a country with fixed exchange rates. Be certain to include a flow chart that shows the repercussions of the increase in the money supply and carefully explain the flow chart.

 

35.       Use the IS-LM-FE framework to illustrate the effects of an expansionary monetary policy with fixed rates. Is monetary policy effective with fixed exchange rates?

 

36.       Explain the effects of expansionary fiscal policy on the balance of payments of a country with fixed exchange rates. Be certain to include a flow chart that shows the repercussions of the expansionary fiscal policy and carefully explain the flow chart.

 

37.       Use the IS-LM-FE framework to show the effects of contractionary fiscal policy in a country with fixed exchange rates. Be certain to include  analysis for both responsive and unresponsive international capital flows. Is fiscal policy effective with fixed exchange rates?

 

38.       Use the IS-LM-FE framework to illustrate the following statements:

 

a.         With fixed exchange rates, international capital-flow shocks can have a big impact on internal balance.

b.         With fixed exchange rates, international trade shocks can have a big impact on internal balance.

 

39.       Use the IS-LM-FE framework to illustrate and explain what happens when a country with a fixed exchange rate devalues its currency. What effect could that devaluation have on the trade balance? Explain. What do you expect will happen to the trade balance over time? Explain.