Macroeconomics, 3e (Williamson) Chapter 14 Money in the Open Economy

1) The nominal exchange rate is the A) domestic currency price of foreign currency. B) foreign currency price of domestic currency. C) price of domestic goods in terms of foreign goods. D) price of foreign goods in terms of domestic goods. Answer: A

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2) The real exchange rate is the A) domestic currency price of foreign currency. B) foreign currency price of domestic currency. C) price of domestic goods in terms of foreign goods. D) price of foreign goods in terms of domestic goods. Answer: D

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3) In an open economy, the law of one price implies that A) the domestic economy may have a comparative advantage in only half the goods it produces. B) perfect competition holds in all domestic markets. C) purchasing power parity should hold. D) the nominal exchange rate should equal one. Answer: C

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4) According to purchasing power parity, the relationship among the domestic price ( P), the foreign price (P), and the nominal exchange rate (e), can be written as A) P = e - P.

B)

P = P - e.

C)

P = eP.

D)

P = e/P.

Answer:

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5)

If purchasing power parity holds, the exchange rate (e) can be expressed as a function of the domestic price (P) and the foreign price (P*) as A) e = P - P*.

B)

e = P* - P.

C)

e = P* + P.

D)

e = P/P*.

Answer:

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6) A principal reason that purchasing power parity does not hold exactly in practice is A) that foreign and domestic assets are not perfect substitutes. B) the existence of non-traded goods. C) that consumers in different countries have different preferences. D) that costs of production are not the same in all countries. Answer: B

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7) iPods are less expensive in Canada than the United States, once the exchange rate is taken into account. This is an indication that A) the nominal exchange rate is equal to one. B) purchasing power parity does not hold. C) the law of one price holds. D) the exchange rate is fixed. Answer: B

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8) Purchasing power parity may not hold in practice due to all of the following except A)

transportation costs. B) cross-country differences in environmental regulations. C) trade barriers like tariffs and quotas. D) the existence of non-traded goods. Answer: B

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9) The Big Mac index, published by The Economist A) computes real exchange rates based on the local currency price of Big Macs in different countries. B) compares the market shares of American fast food companies in different countries. C) compares the barriers to trade erected by different foreign governments. D) computes the relative cost of a Big Mac to the typical full-service restaurant meal in different countries. Answer: A

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10) Over the period from 1989-2006, an examination of purchasing power parity between the United States and Canada shows that A) purchasing power parity held almost exactly between the two countries.

B) the real exchange rate has fluctuated, but has shown no trend. C) Canada's real exchange rate vs. that of the United States has increased by approximately 70%. D) the United States' real exchange rate vs. Canada has increased by approximately 70%. Answer: C

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11) Under purely flexible exchange rates, A) there is no intervention by the domestic fiscal or monetary authorities to specifically target the nominal exchange rate. B) there is only occasional intervention by the domestic fiscal or monetary authorities to specifically target the nominal exchange rate. C) the domestic fiscal and monetary authorities retain considerable flexibility to prevent shortrun variability in the nominal exchange rate. D) the domestic fiscal and monetary authorities retain considerable flexibility to prevent longrun variability in the nominal exchange rate. Answer: A

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12) A devaluation of the exchange rate is a policy action that A) increases the real exchange rate. B) decreases the real exchange rate. C) increases the nominal exchange rate. D) decreases the nominal exchange rate. Answer: C

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13)

A revaluation of the exchange rate is a policy action that A) increases the real exchange rate. B) decreases the real exchange rate. C) increases the nominal exchange rate. D) decreases the nominal exchange rate. Answer: D

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14) A hard peg may be achieved by all of the following except A) following the rules of the Bretton Woods Agreement. B) dollarization. C) establishing a currency board. D) mutual agreements establishing a common currency. Answer: A

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15) Dollarization is a policy action that A) tries to stabilize the value of the local currency vs. the U.S. dollar.

B) adopts the currency of another country as the national medium of exchange. C) mimics policy actions taken by the U.S. Federal Reserve. D) outlaws the holding of foreign currencies other than the U.S. dollar. Answer: B

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16) Which of the following was specifically instituted to ensure a successful hard peg? A) the Bretton Woods Agreement B) the European Monetary System C) the European Monetary Union D) the International Monetary Fund Answer: C

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17) In the European Monetary Union, the supply of euros A) is managed by the individual central banks of the member countries. B) is managed by the European Central Bank. C) is determined by market forces. D) automatically varied in response to short-run fluctuations in the exchange rates of the member nations. Answer: B

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18) The supply of euros is managed by A) the European Monetary Union. B) the European Monetary System. C) the European Central Bank. D) the European Bank for Reconstruction and Development. Answer: C

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19) Adoption of a currency board A)

is one method for achieving a soft peg policy. B) places responsibility for exchange rate management in the hands of an agency that is independent of political influences. C) mandates the use of currency in all domestic transactions. D) requires that a centralized institution holds interest-bearing assets denominated in the currency against which the nominal exchange rate is being fixed. Answer: D

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20) Compared to dollarization, a currency board A) has a flexible exchange rate. B) has a separate currency. C) conducts independent monetary policy. D) is the same institution. Answer: B

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21) Compared to a fixed exchange rate, a monetary union A) involves soft pegs. B)

does not allow adjustments to exchange rates. C) is managed at the International Monetary Fund. D) has no central bank. Answer: B

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22) The Bretton Woods Agreement A) fixed the value of the U.S. dollar relative to gold. B) fixed the value of the U.S. dollar relative to the euro. C) required foreign central banks to hold certain minimum amounts of gold as foreign exchange reserves. D) required member nations, other than the United States, to disband their central banks. Answer: A

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23) A key international institution that plays an important role in exchange rate determination is the A) U.S. Currency Board. B) European Central Bank. C) World Bank. D) International Monetary Fund. Answer: D

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24) The International Monetary Fund plays the key role of A) providing deposit insurance for banks in its member nations. B) acting as lender of last resort for its member countries' central banks. C) providing loans to member countries to help finance development projects. D) enforcing international monetary agreements. Answer: B

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25) Which of the following institutions plays the role of an international lender of last resort? A)

the World Bank B) the International Monetary Fund C) the European Monetary System D) the Federal Reserve System Answer: B

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26) In the monetary small open-economy model with a flexible exchange rate, an increase in the foreign price level has which impact on domestic money demand? A) It increases it. B) It decreases it. C) It has no impact. D) It depends. Answer: A

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27) In the monetary small open-economy model with a flexible exchange rate, an increase in the domestic price level has which impact on domestic money demand? A) It increases it. B)

It decreases it. C) It has no impact. D) It depends. Answer: A

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28) In the monetary small open-economy model with a flexible exchange rate, an increase in the exchange rate has which impact on domestic money demand? A) It increases it. B) It decreases it. C) It has no impact. D) It depends. Answer: A

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29) In the monetary small open-economy model with a flexible exchange rate, an increase in the domestic money supply increases A) domestic output, but has no effect on the domestic price level or the nominal exchange rate. B) the domestic price level, but has no effect on domestic output or the nominal exchange rate. C) the nominal exchange rate, but has no effect on domestic output or the domestic price level. D) the domestic price level and the nominal exchange rate, but has no effect on domestic output. Answer: D

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30) Under a flexible exchange rate, an increase in the domestic money supply leads to A) a devaluation of the domestic currency. B) a revaluation of the domestic currency. C) a depreciation of the domestic currency. D) an appreciation of the domestic currency. Answer: C

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31) In the monetary small open-economy model with a flexible exchange rate, an increase in the

foreign price level decreases A) domestic output, but has no effect on the domestic price level or the nominal exchange rate. B) the domestic price level, but has no effect on domestic output or the nominal exchange rate. C) the nominal exchange rate, but has no effect on domestic output or the domestic price level. D) the domestic price level and the nominal exchange rate, but has no effect on domestic output. Answer: C

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32) In the monetary small open-economy model with a flexible exchange rate, an increase in the world real interest rate A) increases domestic output and increases the nominal exchange rate, as long as real money demand is much more responsive to real income than to the real interest rate. B) increases domestic output and decreases the nominal exchange rate, as long as real money demand is much more responsive to real income than to the real interest rate. C) decreases domestic output and increases the nominal exchange rate, as long as real money demand is much more responsive to real income than to the real interest rate. D) decreases domestic output and decreases the nominal exchange rate, as long as real money demand is much more responsive to real income than to the real interest rate. Answer: B

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33)

In the monetary small open-economy model with a fixed exchange rate, an increase in the foreign price level has which impact on domestic money demand? A) It increases it. B) It decreases it. C) It has no impact. D) It depends. Answer: A

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34) In the monetary small open-economy model with a fixed exchange rate, an increase in the domestic price level has which impact on domestic money demand? A) It increases it. B) It decreases it. C) It has no impact. D) It depends. Answer: A

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35) In the monetary small open-economy model with a fixed exchange rate, an increase in the exchange rate has which impact on domestic money demand?

A) It increases it. B) It decreases it. C) It has no impact. D) It depends. Answer: A

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36) For a country with a fixed exchange rate, foreign exchange reserves are A) an asset of the domestic government. B) a liability of the domestic government. C) held by private banks. D) are unnecessary. Answer: A

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37) To maintain a fixed exchange rate, authorities A) make laws stipulating the exchange rate. B)

modify money supply. C) modify government expenses. D) modify taxes. Answer: B

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38) In the monetary small open-economy model with a fixed exchange rate, the domestic A) government loses control over the level of domestic government spending. B) government loses control over the level of domestic taxes. C) government loses control over the level of domestic government spending and domestic taxes. D) central bank loses control over the domestic stock of money. Answer: D

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39) In the monetary small open-economy model with a fixed exchange rate, an increase in the foreign price level A) increases the domestic money supply and increases the domestic price level. B) increases the domestic money supply and decreases the domestic price level. C) decreases the domestic money supply and increases the domestic price level. D) decreases the domestic money supply and decreases the domestic price level. Answer: A

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40) In the monetary small open-economy model with a fixed exchange rate, an increase in the world real interest rate A) increases domestic output and has no effect on the domestic price level. B) decreases domestic output and has no effect on the domestic price level. C) increases the domestic price level and has no effect on domestic output. D) decreases the domestic price level and has no effect on domestic output. Answer: A

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41) In the monetary small open-economy model with a fixed exchange rate, a devaluation of the

domestic currency in the absence of any other shocks A) increases the current account surplus and has no effect on the domestic money supply. B) decreases the current account surplus and has no effect on the domestic money supply. C) increases the domestic money supply and has no effect on the current account surplus. D) decreases the domestic money supply and has no effect on the current account surplus. Answer: D

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42) In the monetary small open-economy model with a fixed exchange rate, a temporary decrease in domestic total factor productivity in the absence of any other shocks A) increases the current account surplus and increases the domestic money supply. B) increases the current account surplus and decreases the domestic money supply. C) increases the domestic money supply and decreases the current account surplus. D) decreases the domestic money supply and decreases the current account surplus. Answer: D

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43) In the monetary small open-economy model, a fixed exchange rate insulates the domestic price level from A)

both real and nominal shocks from abroad. B) real shocks from abroad, but not nominal shocks from abroad. C) nominal shocks from abroad, but not from real shocks from abroad. D) neither real nor nominal shocks from abroad. Answer: B

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44) In the monetary small open-economy model, a flexible exchange rate insulates the domestic price level from A) both real and nominal shocks from abroad. B) real shocks from abroad, but not from nominal shocks from abroad. C) nominal shocks from abroad, but not from real shocks from abroad. D) neither real nor nominal shocks from abroad. Answer: C

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45) A natural region over which a single currency dominates as a medium of exchange is called A) sovereign nation. B)

monetary union area. C) common currency area. D) currency union. Answer: C

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46) An agreement among countries to adopt a common currency is called a A) central bank consolidation. B) currency union. C) monetary compact. D) common banking treaty. Answer: B

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47) What is the major problem in a currency union? A) Money demand becomes more erratic. B) Participating central banks may not agree on monetary policy. C) It is akin to dollarization.

D) The capital account becomes difficult to define. Answer: B

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48) A capital inflow occurs when a A) domestic resident purchases a domestic asset. B) domestic resident purchases a foreign asset. C) foreign resident purchases a domestic asset. D) foreign resident purchases a foreign asset. Answer: C

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49) A capital outflow occurs when a A) domestic resident purchases a domestic asset. B) domestic resident purchases a foreign asset. C) foreign resident purchases a domestic asset. D) foreign resident purchases a foreign asset. Answer:

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50) The balance of payments is zero A) as an accounting identity. B) because market forces ensure that this is so. C) only if the current account balance is zero. D) only if the capital account balance is zero. Answer: A

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51) The balance of payments improves A) when there is an exchange rate appreciation. B) when there is an exchange rate depreciation. C) when the interest rate rises. D) never. Answer: D

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52) The balance of payments equals A) the current account surplus plus the capital account surplus. B) the current account surplus plus the capital account deficit. C) the current account deficit plus the capital account surplus. D) the current account deficit plus the capital account deficit. Answer: A

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53) The acquisition of a new physical asset by a foreign resident is called A)

foreign direct investment. B) foreign capital investment. C) a portfolio inflow. D) a portfolio outflow. Answer: A

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54) The acquisition of a domestic financial asset by a foreign resident is called A) foreign direct investment. B) foreign capital investment. C) a portfolio inflow. D) a portfolio outflow. Answer: C

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55) In response to a temporary change in total factor productivity, the adoption of capital controls under a flexible exchange rate A) amplifies the effect of this disturbance on both domestic output and the nominal exchange rate. B)

amplifies the effect of this disturbance on domestic output and dampens the effect on the nominal exchange rate. C) dampens the effect of this disturbance on domestic output and amplifies the effect on the nominal exchange rate. D) dampens the effect of this disturbance on both domestic output and the nominal exchange rate. Answer: D

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56) In response to a temporary change in total factor productivity, the adoption of capital controls under a fixed exchange rate A) amplifies the effect of this disturbance on both domestic output and the domestic nominal money supply. B) amplifies the effect of this disturbance on domestic output and dampens the effect on the domestic nominal money supply. C) dampens the effect of this disturbance on domestic output and amplifies the effect on domestic nominal money supply. D) dampens the effect of this disturbance on both domestic output and the domestic nominal money supply. Answer: D

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57) The adoption of capital controls makes A) everyone in the domestic economy better off. B) some domestic residents better off and some worse off, although on average welfare increases. C) some domestic residents better off and some worse off, although on average welfare decreases. D) everyone in the domestic economy worse off. Answer: C

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