CHAPTER 16MACROECONOMIC POLICY IN AN OPEN ECONOMY

MULTIPLE CHOICE
1. A nation experiences internal balance if it achieves:
a
.
Full employment
b
.
Price stability
c
.
Full employment and price stability
d
.
Unemployment and price instability
ANS: C PS: 1
!. A nation experiences external balance if it achieves:
a
.
No net chan"es in its international "old stoc#s
b
.
Productivity levels e$ual to those of its tradin" partners
c
.
An increase in its money supply e$ual to increases overseas
d
.
%$uilibrium in its balance of payments
ANS: & PS: 1
'. A nation experiences overall balance if it achieves:
a
.
(alance)of)payments e$uilibrium* full employment* and price stability
b
.
(alance)of)payments e$uilibrium* maximum productivity* and price stability
c
.
Full employment* price stability and no chan"e in its money supply
d
.
Full employment* price stability* and maximum productivity
ANS: A PS: 1
+. ,ost industrial countries "enerally considered ---- as the most important economic "oal.
a
.
%xternal balance
b
.
.nternal balance
c
.
,aximum efficiency for business
d
.
,aximum efficiency for labor
ANS: ( PS: 1
/. 0hich policies are expenditure)chan"in" policies1
a
.
Currency devaluation and revaluation
b
.
.mport $uotas and tariffs
c
.
,onetary and fiscal policy
d
.
0a"e and price controls
ANS: C PS: 1
2. 0hich policy is an expenditure)s3itchin" policy1
a
.
.ncrease in the money supply
b
.
&ecrease in "overnment expenditures
c
.
.ncrease in business and household taxes
d
.
&ecrease in import tariffs
ANS: & PS: 1
4. An expenditure)increasin" policy 3ould consist of an increase in:
a
.
.mport tariffs
b
.
.mport $uotas
c
.
5overnmental taxes
d
.
he money supply
ANS: & PS: 1
6. An expenditure)reducin" policy 3ould consist of a decrease in:
a
.
he par value of a currency
b
.
5overnment expenditures
c
.
.mport duties
d
.
(usiness or household taxes
ANS: ( PS: 1
7. 5iven fixed exchan"e rates* assume ,exico initiates expansionary monetary and fiscal policies to
combat recession. hese policies 3ill also:
a
.
.ncrease both imports and exports
b
.
.ncrease exports and reduce imports
c
.
8educe a balance)of)payments surplus
d
.
8educe a balance)of)payments deficit
ANS: C PS: 1
19. 5iven fixed exchan"e rates* assume ,exico initiates contractionary monetary and fiscal policies to
combat inflation. hese policies 3ill also:
a
.
8educe a balance)of)payments surplus
b
.
8educe a balance)of)payments deficit
c
.
.ncreases both imports and exports
d
.
&ecrease both imports and exports
ANS: ( PS: 1
11. he appropriate expenditure)s3itchin" policy to correct a current account surplus is:
a
.
Currency revaluation
b
.
Currency devaluation
c
.
%xpansionary monetary policy
d
.
Contractionary fiscal policy
ANS: A PS: 1
1!. he appropriate expenditure)s3itchin" policy to correct a current account deficit is:
a
.
Contractionary monetary policy
b
.
%xpansionary fiscal policy
c
.
Currency devaluation
d
.
Currency revaluation
ANS: C PS: 1
1'. Suppose the United States faces domestic recession and a current account deficit. Should the United
States devalue the dollar* one 3ould expect the:
a
.
8ecession to become less severe))deficit to become less severe
b
.
8ecession to become more severe))deficit to become less severe
c
.
8ecession to become less severe))deficit to become more severe
d
.
8ecession to become more severe))deficit to become more severe
ANS: A PS: 1
1+. Suppose the United States faces domestic inflation and a current account surplus. Should the United
States revalue the dollar* one 3ould expect the:
a
.
.nflation to become more severe))surplus to become less severe
b
.
.nflation to become less severe))surplus to become less severe
c
.
.nflation to become less severe))surplus to become more severe
d
.
.nflation to become more severe))surplus to become more severe
ANS: ( PS: 1
1/. Suppose (ra:il faces domestic recession and a current account surplus. Should (ra:il revalue its
currency* one 3ould expect the:
a
.
8ecession to become less severe))surplus to become less severe
b
.
8ecession to become more severe))surplus to become more severe
c
.
8ecession to become more severe))surplus to become less severe
d
.
8ecession to become less severe))surplus to become more severe
ANS: C PS: 1
12. Suppose that (ra:il faces domestic inflation and a current account deficit. Should (ra:il devalue its
currency* one 3ould expect the:
a
.
.nflation to become more severe))deficit to become less severe
b
.
.nflation to become more severe))deficit to become more severe
c
.
.nflation to become less severe))deficit to become less severe
d
.
.nflation to become less severe))deficit to become more severe
ANS: A PS: 1
14. .n a closed economy* 3hich of the follo3in" 3ill cause the economy;s a""re"ate demand curve to shift
to the ri"ht1
a
.
decreases and 3a"es and salaries paid to employees
b
.
increases in the prices of oil and natural "as
c
.
decreases in income taxes for households
d
.
decreases in the productivity of labor
ANS: C PS: 1
16. 5iven an open economy 3ith hi"h capital mobility and floatin" exchan"e rates* suppose an
expansionary monetary policy is implemented to combat recession. he initial and secondary effects of
the policy
a
.
cause a""re"ate demand to increase* thus stren"thenin" the policy;s expansionary effect
on real output
b
.
cause a""re"ate demand to decrease* thus eliminatin" the policy;s expansionary effect on
real output
c
.
have conflictin" effects on a""re"ate demand* thus 3ea#enin" the policy;s expansionary
effect on real output
d
.
have conflictin" effects on a""re"ate demand* thus stren"thenin" the policy;s
expansionary effect on real output
ANS: A PS: 1
17. A problem that economic policy ma#ers confront 3hen attemptin" to promote both internal and
external balance for the nation is that monetary or fiscal policies aimed at the domestic sector also
have impacts on:
a
.
rade flo3s only
b
.
Capital flo3s only
c
.
both trade flo3s and capital flo3s
d
.
Neither trade flo3s nor capital flo3s
ANS: C PS: 1
!9. 5iven an open economy 3ith hi"h capital mobility and floatin" exchan"e rates* suppose an
expansionary fiscal policy is implemented to combat recession. he initial and secondary effects of the
policy
a
.
cause a""re"ate demand to increase* thus stren"thenin" the policy;s expansionary effect
on real output
b
.
cause a""re"ate demand to decrease* thus eliminatin" the policy;s expansionary effect on
real output
c
.
have conflictin" effects on a""re"ate demand* thus 3ea#enin" the policy;s expansionary
effect on real output
d
.
have conflictin" effects on a""re"ate demand* thus stren"thenin" the policy;s
expansionary effect on real output
ANS: C PS: 1
!1. A system of fixed exchan"e rates and hi"h capital mobility stren"thens 3hich policy in combatin" a
recession:
a
.
%xpansionary fiscal policy
b
.
%xpansionary monetary policy
c
.
Contractionary fiscal policy
d
.
Contractionary monetary policy
ANS: A PS: 1
!!. A system of floatin" exchan"e rates and hi"h capital mobility stren"thens 3hich policy in combatin" a
recession:
a
.
%xpansionary fiscal policy
b
.
%xpansionary monetary policy
c
.
Contractionary fiscal policy
d
.
Contractionary monetary policy
ANS: ( PS: 1
!'. 5iven an open economy 3ith hi"h capital mobility* all of the follo3in" statements are true except:
a
.
fiscal policy is stren"thened under fixed exchan"e rates
b
.
monetary policy is 3ea#ened under fixed exchan"e rates
c
.
monetary policy is stren"thened under floatin" exchan"e rates
d
.
fiscal policy is stren"thened under floatin" exchan"e rates
ANS: & PS: 1
!+. Under a system of mana"ed)floatin" exchan"e rates 3ith heavy exchan"e rate intervention:
a
.
Fiscal policy is successful in promotin" internal balance* 3hile monetary policy is
unsuccessful
b
.
,onetary policy is successful in promotin" internal balance* 3hile fiscal policy is
unsuccessful
c
.
(oth fiscal policy and monetary policy are successful in promotin" internal balance
d
.
Neither fiscal policy nor monetary policy are successful in promotin" internal balance
ANS: ( PS: 1
!/. 5iven a system of floatin" exchan"e rates* an expansionary monetary policy by the Federal 8eserve
3ill cause
a
.
the dollar to appreciate and 3ill decrease U.S. net exports
b
.
the dollar to appreciate and 3ill increase U.S. net exports
c
.
the dollar to depreciate and 3ill increase U.S. net exports
d
.
the dollar to depreciate and 3ill decrease U.S. net exports
ANS: C PS: 1
!2. 5iven a system of floatin" exchan"e rates* a contractionary monetary policy by the Federal 8eserve
3ill cause
a
.
the dollar to appreciate and 3ill decrease U.S. net exports
b
.
the dollar to appreciate and 3ill increase U.S. net exports
c
.
the dollar to depreciate and 3ill increase U.S. net exports
d
.
the dollar to depreciate and 3ill decrease U.S. net exports
ANS: A PS: 1
!4. All of the follo3in" are obstacles to international economic policy coordination except:
a
.
&ifferent national ob<ectives and institutions
b
.
&ifferent national political climates
c
.
&ifferent phases in the business cycle
d
.
&ifferent national currencies
ANS: & PS: 1
!6. Suppose a central ban# prevents a depreciation of its currency by intervenin" in the forei"n exchan"e
mar#et and buyin" its currency 3ith forei"n currency. his causes the
a
.
domestic money supply to decrease and a decline in a""re"ate demand
b
.
domestic money supply to increase and a decline in a""re"ate demand
c
.
domestic money supply to decrease and a rise in a""re"ate demand
d
.
domestic money supply to increase and a rise in a""re"ate demand
ANS: A PS: 1
!7. At the ----* the 5roup)of)Five nations a"reed to intervene in the currency mar#ets to promote a
depreciation in the U.S. dollar;s exchan"e value.
a
.
Pla:a A"reement of 176/
b
.
=ouvre Accord of 1764
c
.
(onn Summit of 1746
d
.
o#yo Summit of 172!
ANS: A PS: 1
'9. he Pla:a A"reement of 176/ and =ouvre Accord of 1764 are examples of:
a
.
ariff trade barrier formation
b
.
Nontariff trade barrier formation
c
.
.nternational economic policy coordination
d
.
(e""ar)thy)nei"hbor policies
ANS: C PS: 1
Exhibit 16.1
At the Pla:a Accord of 176/* the 5roup)of)Five nations a"reed to drive the value of the dollar
do3n3ard >i.e.* depreciation? so as to help reduce the U.S. trade deficit. Ans3er the follo3in"
$uestion>s? on the basis of this information.
'1. 8efer to %xhibit 12.1. o help drive the dollar;s exchan"e value do3n3ard* the Federal 8eserve 3ould:
a
.
8educe taxes
b
.
.ncrease taxes
c
.
&ecrease the money supply
d
.
.ncrease the money supply
ANS: & PS: 1
'!. 8efer to %xhibit 12.1. he Federal 8eserve mi"ht refuse to support the accord on the "rounds that
3hen helpin" to drive the dollar;s exchan"e value do3n3ard* it promotes an increase in the U.S.:
a
.
8ate of inflation
b
.
(ud"et deficit
c
.
Unemployment level
d
.
%conomic "ro3th rate
ANS: A PS: 1
''. Under a fixed exchan"e)rate system and hi"h capital mobility* an expansion in the domestic money
supply leads to:
a
.
rade)account deficit and a capital)account surplus
b
.
rade)account deficit and a capital)account deficit
c
.
rade)account surplus and a capital)account surplus
d
.
rade)account surplus and a capital)account deficit
ANS: ( PS: 1
'+. Under a fixed exchan"e)rate system and hi"h capital mobility* a contraction in the domestic money
supply leads to a:
a
.
rade)account deficit and a capital)account surplus
b
.
rade)account deficit and a capital)account deficit
c
.
rade)account surplus and a capital)account surplus
d
.
rade)account surplus and a capital)account deficit
ANS: C PS: 1
'/. Under a fixed exchan"e)rate system and hi"h capital mobility* an expansionary fiscal policy leads to a:
a
.
rade)account deficit and a capital)account surplus
b
.
rade)account deficit and a capital)account deficit
c
.
rade)account surplus and a capital)account surplus
d
.
rade)account surplus and a capital)account deficit
ANS: A PS: 1
'2. Under a fixed exchan"e)rate system and hi"h capital mobility* a contractionary fiscal policy leads to a:
a
.
rade)account deficit and a capital)account surplus
b
.
rade)account deficit and a capital)account deficit
c
.
rade)account surplus and a capital)account surplus
d
.
rade)account surplus and a capital)account deficit
ANS: & PS: 1
'4. Suppose a central ban# prevents a depreciation of its currency by intervenin" in the forei"n exchan"e
mar#et and buyin" its currency 3ith forei"n currency. his causes the
a
.
domestic money supply to decrease and a decline in a""re"ate demand
b
.
domestic money supply to increase and a decline in a""re"ate demand
c
.
domestic money supply to decrease and a rise in a""re"ate demand
d
.
domestic money supply to increase and a fall in a""re"ate demand
ANS: A PS: 1
'6. Suppose a central ban# prevents an appreciation of its currency by intervenin" in the forei"n exchan"e
mar#et and sellin" its currency for forei"n currency. his causes the
a
.
domestic money supply to decrease and a decline in a""re"ate demand
b
.
domestic money supply to increase and a decline in a""re"ate demand
c
.
domestic money supply to decrease and a rise in a""re"ate demand
d
.
domestic money supply to increase and a fall in a""re"ate demand
ANS: C PS: 1
'7. Assume a system of floatin" exchan"e rates. .n response to relatively hi"h interest rates abroad*
suppose domestic investors place their funds in forei"n capital mar#ets. he result 3ould be
a
.
a depreciation of the domestic currency and a rise in net exports
b
.
a depreciation of the domestic currency and a fall in net exports
c
.
an appreciation of the domestic currency and a rise in net exports
d
.
an appreciation of the domestic currency and a fall in net exports
ANS: A PS: 1
+9. Assume a system of floatin" exchan"e rates. .n response to relatively hi"h domestic interest rates*
suppose that forei"n investors place their funds in domestic capital mar#ets. he result 3ould be
a
.
a depreciation of the domestic currency and a rise in net exports
b
.
a depreciation of the domestic currency and a fall in net exports
c
.
an appreciation of the domestic currency and a rise in net exports
d
.
an appreciation of the domestic currency and a fall in net exports
ANS: & PS: 1
+1. 0hen a nation reali:es external balance
a
.
it can have a current account deficit
b
.
it can have a current account surplus
c
.
it has neither a current account deficit nor a current account surplus
d
.
(oth a and b
ANS: C PS: 1
+!. &irect controls may ta#e the form of
a
.
ariffs
b
.
%xport subsidies
c
.
%xport $uotas
d
.
All of the above
ANS: & PS: 1
+'. 0ith a fixed exchan"e rate system* internal balance is most effectively achieved by usin"
a
.
%xpansionary monetary policy to combat recession
b
.
%xpansionary fiscal policy to combat inflation
c
.
Contractionary monetary policy to combat recession
d
.
Contractionary fiscal policy to combat recession
ANS: A PS: 1
++. Policy coordination is complicated by
a
.
&ifferent economic ob<ectives
b
.
&ifferent national institutions
c
.
&ifferent phases in the business cycle
d
.
All of the above
ANS: & PS: 1
TRUE/FALSE
1. A nation reali:es internal balance if economy achieves full employment and price stability.
ANS: PS: 1
!. Nations have typically placed "reater importance to the "oal of internal balance than to the "oal of
external balance.
ANS: PS: 1
'. A nation reali:es external balance 3hen its current account is in e$uilibrium.
ANS: PS: 1
+. A nation reali:es overall balance 3hen it achieves full employment and current account e$uilibrium.
ANS: F PS: 1
/. %xpenditure)chan"in" policies modify the direction of a""re"ate demand* shiftin" it bet3een domestic
output and imports.
ANS: PS: 1
2. %xpenditure)s3itchin" policies include fiscal policy and monetary policy.
ANS: F PS: 1
4. %conomic policyma#ers have typically adopted expenditure)increasin" policies to combat inflation
and expenditure)reducin" policies to combat recession.
ANS: F PS: 1
6. %xpenditure)s3itchin" policies alter the level of total spendin" >a""re"ate demand? for "oods and
services produced domestically and those imported.
ANS: F PS: 1
7. Currency devaluation and revaluation are considered to be expenditure)chan"in" policies since they
alter a country;s a""re"ate demand for "oods and services.
ANS: F PS: 1
19. %xpenditure)s3itchin" policies include currency revaluation* currency devaluation* and direct controls
such as tariffs* $uotas* and subsidies.
ANS: PS: 1
11. 5iven an open economy 3ith hi"h capital mobility and floatin" exchan"e rates* suppose an
expansionary monetary policy is implemented to combat recession. he initial and secondary effects of
the policy have conflictin" effects on a""re"ate demand* thus 3ea#enin" the policy;s expansionary
effect.
ANS: F PS: 1
1!. 5iven an open economy 3ith hi"h capital mobility and fixed exchan"e rates* suppose an expansionary
fiscal policy is implemented to combat recession. he initial and secondary effects of the policy cause
a""re"ate demand to increase* thus stren"thenin" the policy;s expansionary effect.
ANS: PS: 1
1'. 0hen the economy is in deep recession or depression* it is operatin" on that portion of its a""re"ate
supply curve that is hori:ontal.
ANS: PS: 1
1+. Chan"es in a country;s net exports* investment spendin"* or "overnment spendin" 3ill cause its
a""re"ate demand curve to shift.
ANS: PS: 1
1/. 5iven an open economy 3ith hi"h capital mobility* fiscal policy is stren"thened under fixed exchan"e
rates.
ANS: PS: 1
12. 5iven an open economy 3ith hi"h capital mobility* monetary policy is stren"thened under fixed
exchan"e rates.
ANS: F PS: 1
14. Under floatin" exchan"e rates and hi"h capital mobility* an expansionary monetary policy 3ould help
a country resolve a recession and a current account deficit.
ANS: F PS: 1
16. %xchan"e rate mana"ement policies re$uire international policy coordination because a depreciation of
one nation;s currency implies an appreciation of its tradin" partner;s currency.
ANS: PS: 1
17. Currency devaluation and revaluation primarily affect the economy;s current account and have
secondary effects on domestic employment and inflation.
ANS: PS: 1
!9. Fiscal and monetary policies are "enerally used to combat domestic recession and inflation and have
secondary effects on the balance of payments.
ANS: PS: 1
!1. he 5roup of five >5)/? nations include @apan* 5ermany* China* and Australia.
ANS: F PS: 1
!!. he (onn Summit of 1746 and Pla:a Accord of 176/ are examples of international policy
coordination.
ANS: PS: 1
!'. .nternational policy coordination is pla"ued by differin" national economic ob<ectives* institutions*
political climates* and phases in the business cycle.
ANS: PS: 1
!+. he "oals of the Pla:a A"reement of 176/ 3ere to combat protectionism in the U.S. Con"ress*
promote 3orld economic expansion by stimulatin" demand in 5ermany and @apan* and to ease the
burden of the U.S. debt service.
ANS: PS: 1
SHORT ANSWER
1. 0hat policy instrument should be used 3hen demand)pull inflation exists1
ANS:
0ith demand)pull inflation* internal balance can be vie3ed as a sin"le tar"et that re$uires reduction in
a""re"ate demand via monetary policy or fiscal policy.
PS: 1
!. 0hat happens to the balance of payments under a fixed exchan"e rate system* 3hen expansionary or
contractionary monetary policy is used1
ANS:
Under a fixed exchan"e rate system* the balance of payments position is 3orsened 3hen expansionary
monetary policy is used. Alternatively* the balance of payments position improves 3ith the use of
contractionary policy.
PS: 1
ESSAY
1. 0as the Pla:a A"reement of 176/ a success1
ANS:
he Pla:a A"reement 3as "enerally vie3ed as a modest success. he United States and 0est 5ermany
disa"reed over the rate of inflation in 0est 5ermany. he slo3 pro"ress made by the United States in
reducin" the bud"et deficit in 1764 also strained the pact. he a"reement* ho3ever* survived numerous
attac#s* 3ith participatin" nations repeatedly expressin" support for it.
PS: 1
!. 0hat is international economic policy coordination1
ANS:
.nternational economic policy coordination is the attempt to si"nificantly modify national policies in
reco"nition of international economic interdependence. Nations re"ularly consult 3ith each other in
the context of the .,F* A%C&* (an# for .nternational Settlements* and 5roup of Seven. he Pla:a
A"reement and =ouvre Accord are examples of international economic policy coordination.
PS: 1