Question 1

Why would lowering its own interest rates affect a nation's exchange rate?

Accepted Answer

A)  International interest arbitrage (the ability to borrow in low-rate markets and deposit in higher-rate markets) would cause investors to sell domestic currency assets and purchase foreign assets based in other currencies. 
B)  A nation's central bank controls both interest rates and exchange rates. Unfortunately, they do not have sufficient funds to take care of both at the same time. 
C)  When interest rates fall, borrowing is cheaper, spending and GDP rise and so do exports, thus causing the exchange rate to appreciate. 
D)  In the short run, exchange rates have to adhere to PPP; otherwise, traders will make profits by purchasing in the cheap market and selling in the more expensive market, thus aligning exchange rates at the proper level. 
A)  International interest arbitrage (the ability to borrow in low-rate markets and deposit in higher-rate markets) would cause investors to sell domestic currency assets and purchase foreign assets based in other currencies. 
B)  A nation's central bank controls both interest rates and exchange rates. Unfortunately, they do not have sufficient funds to take care of both at the same time. 
C)  When interest rates fall, borrowing is cheaper, spending and GDP rise and so do exports, thus causing the exchange rate to appreciate. 
D)  In the short run, exchange rates have to adhere to PPP; otherwise, traders will make profits by purchasing in the cheap market and selling in the more expensive market, thus aligning exchange rates at the proper level.

Question 2

Menu costs are the:

Accepted Answer

A)  cost of changing interest rates. 
B)  cost of converting currencies. 
C)  cost of changing prices. 
D)  cost of changing exchange rates. 
A)  cost of changing interest rates. 
B)  cost of converting currencies. 
C)  cost of changing prices. 
D)  cost of changing exchange rates.

Question 3

If the U.S. interest rate is 9% and the Eurozone interest rate is 5%, then in the short run we would expect:

Accepted Answer

A)  the dollar to appreciate. 
B)  the dollar to depreciate. 
C)  the euro to appreciate. 
D)  There is no change in the exchange rate. 
A)  the dollar to appreciate. 
B)  the dollar to depreciate. 
C)  the euro to appreciate. 
D)  There is no change in the exchange rate.

Question 4

(Figure: The Domestic Interest Rate) Using the graph, if the dollar rate of interest increases from 5% to 7%, what result will occur in the short run?

Accepted Answer

A)  Expectations of future exchange rates will change. 
B)  U.S. real GDP will fall and the dollar will also fall. 
C)  The spot rate for dollars will appreciate to $1.10. 
D)  The nominal interest rate on the euro will decrease. 
A)  Expectations of future exchange rates will change. 
B)  U.S. real GDP will fall and the dollar will also fall. 
C)  The spot rate for dollars will appreciate to $1.10. 
D)  The nominal interest rate on the euro will decrease.

Question 5

A country with a fixed exchange rate faces:

Accepted Answer

A)  no monetary policy constraints in the long run. 
B)  no monetary policy constraints in the short run. 
C)  no monetary policy constraints in the long run and the short run. 
D)  monetary policy constraints in the long run and the short run. 
A)  no monetary policy constraints in the long run. 
B)  no monetary policy constraints in the short run. 
C)  no monetary policy constraints in the long run and the short run. 
D)  monetary policy constraints in the long run and the short run.

Question 6

In the short run, the chain of causality between monetary policy and the exchange rate under fixed rates differs from a floating rate. How?

Accepted Answer

A)  In a fixed rate regime, the money supply is determined first, then interest rates, then the short-run exchange rate. 
B)  In a fixed rate regime, interest rates are determined first, then the money supply, and then the short-run exchange rate. 
C)  In a floating rate regime, exchange rates are determined first, then the nominal interest rate (according to uncovered interest parity), and then the money supply. 
D)  In a fixed rate regime, exchange rates are determined first, then the nominal interest rate (according to uncovered interest parity), and then the money supply. 
A)  In a fixed rate regime, the money supply is determined first, then interest rates, then the short-run exchange rate. 
B)  In a fixed rate regime, interest rates are determined first, then the money supply, and then the short-run exchange rate. 
C)  In a floating rate regime, exchange rates are determined first, then the nominal interest rate (according to uncovered interest parity), and then the money supply. 
D)  In a fixed rate regime, exchange rates are determined first, then the nominal interest rate (according to uncovered interest parity), and then the money supply.

Question 7

What are the consequences for a nation that keeps its exchange rate fixed, holds its own domestic interest rates below market to encourage domestic spending, and allows free foreign investment?

Accepted Answer

A)  Foreign investors will not invest, so the only consequence will be a decline in the inflow of foreign investment. 
B)  Domestic and foreign investors will invest in other nations, causing a sell-off of the domestic currency and, to maintain fixed rates, the central bank will have to buy its own currency, depleting its treasury reserves. 
C)  There will be upward pressure on the rate of interest as more borrowing occurs, so the central bank will have to increase the stock of money. 
D)  Interest rates in other nations will also fall as banks and other firms have to compete for international borrowers. 
A)  Foreign investors will not invest, so the only consequence will be a decline in the inflow of foreign investment. 
B)  Domestic and foreign investors will invest in other nations, causing a sell-off of the domestic currency and, to maintain fixed rates, the central bank will have to buy its own currency, depleting its treasury reserves. 
C)  There will be upward pressure on the rate of interest as more borrowing occurs, so the central bank will have to increase the stock of money. 
D)  Interest rates in other nations will also fall as banks and other firms have to compete for international borrowers.

Question 8

The dependent variable (vertical axis) in standard graphical treatments of the money market is:

Accepted Answer

A)  the exchange rate. 
B)  the real rate of interest. 
C)  real GDP. 
D)  the nominal rate of interest. 
A)  the exchange rate. 
B)  the real rate of interest. 
C)  real GDP. 
D)  the nominal rate of interest.

Question 9

Suppose domestic interest rates are at 4.55%, while foreign returns are bringing 6.38%. According to the asset approach, if the expected future exchange rate is three dollars per unit of foreign currency, what can we say about the current spot rate if UIP holds?

Accepted Answer

The Uncovered Interest Parity (UIP) theo

Question 10

Assuming sticky prices and given expectations of future exchange rates, what is the short-run effect on the exchange rate of the U.S. dollar (purchasing euros) and on domestic and foreign rates of return if there is a temporary increase in the quantity of U.S. dollars?

Accepted Answer

A)  Rates of return on domestic and foreign assets diverge, as the dollar appreciates. 
B)  Domestic and foreign rates of return both fall, as the dollar depreciates. 
C)  Domestic and foreign rates of return converge, as the dollar depreciation lowers returns for U.S. investors who purchase euro-based assets. 
D)  Rates of return on euro assets fall, causing investors to switch into U.S. assets and, therefore, the U.S. dollar appreciates against the euro. 
A)  Rates of return on domestic and foreign assets diverge, as the dollar appreciates. 
B)  Domestic and foreign rates of return both fall, as the dollar depreciates. 
C)  Domestic and foreign rates of return converge, as the dollar depreciation lowers returns for U.S. investors who purchase euro-based assets. 
D)  Rates of return on euro assets fall, causing investors to switch into U.S. assets and, therefore, the U.S. dollar appreciates against the euro.

Question 11

From full long-run equilibrium, expectations of future exchange rates can only change when there is a:

Accepted Answer

A)  political change. 
B)  permanent change in the quantity of money. 
C)  change in short-run interest rates. 
D)  temporary decrease in the quantity of money. 
A)  political change. 
B)  permanent change in the quantity of money. 
C)  change in short-run interest rates. 
D)  temporary decrease in the quantity of money.

Question 12

If UIP holds, the interest rate at home is 4%, and the exchange rate is expected to depreciate by 3%, then the foreign interest rate is:

Accepted Answer

A)  1%. 
B)  3%. 
C)  7%. 
D)  12%. 
A)  1%. 
B)  3%. 
C)  7%. 
D)  12%.

Question 13

Two currencies existed in Iraq before the U.S. invasion and subsequent conflict. What lessons are there for students of exchange rates?

Accepted Answer

A)  Exchange rate values are influenced not only by economic fundamentals but by political events that change long-run expectations of future currency values. 
B)  Iraq did not back its currency with gold and, therefore, it was worth much less than the U.S. dollar. 
C)  Eventually each Iraqi sect developed its own currency and payments system. 
D)  Exchange rate values are solely influenced by economic policy. 
A)  Exchange rate values are influenced not only by economic fundamentals but by political events that change long-run expectations of future currency values. 
B)  Iraq did not back its currency with gold and, therefore, it was worth much less than the U.S. dollar. 
C)  Eventually each Iraqi sect developed its own currency and payments system. 
D)  Exchange rate values are solely influenced by economic policy.

Question 14

The behavior of exchange rates during the period 1999-2004 ____ predictable based on the short run asset model if we assume that changes in the money supply were assumed to be _________.

Accepted Answer

A)  was not; temporary 
B)  was; temporary 
C)  was not; permanent 
D)  was; permanent 
A)  was not; temporary 
B)  was; temporary 
C)  was not; permanent 
D)  was; permanent

Question 15

A key assumption to ensure that domestic returns and foreign returns are in equilibrium is:

Accepted Answer

A)  there are perfectly flexible prices. 
B)  the quantity of money is fixed. 
C)  there are no capital controls preventing the movement of capital. 
D)  trade is not subject to any restrictions. 
A)  there are perfectly flexible prices. 
B)  the quantity of money is fixed. 
C)  there are no capital controls preventing the movement of capital. 
D)  trade is not subject to any restrictions.

Question 16

Explain why an increase in the European interest rate increases the dollar-euro exchange rate.

Accepted Answer

An increase in the European interest rat

Question 17

If Bulgaria, for instance, wished to keep its exchange rate with the dollar fixed, what monetary policy options are available to lower unemployment in the short run?

Accepted Answer

A)  Bulgaria has all the options available to it, because domestic monetary policy is conducted inside the nation and has no bearing on its international variables. 
B)  Traders would realize that any monetary policy actions taken inside a nation would improve economic conditions without affecting international variables. 
C)  Bulgaria cannot use any monetary policy that would cause its short-run exchange rate to depreciate against the dollar. 
D)  Bulgaria's monetary action would restore confidence and help keep its currency stable. 
A)  Bulgaria has all the options available to it, because domestic monetary policy is conducted inside the nation and has no bearing on its international variables. 
B)  Traders would realize that any monetary policy actions taken inside a nation would improve economic conditions without affecting international variables. 
C)  Bulgaria cannot use any monetary policy that would cause its short-run exchange rate to depreciate against the dollar. 
D)  Bulgaria's monetary action would restore confidence and help keep its currency stable.

Question 18

If the domestic dollar return (home nominal interest rate) is 5%, and the foreign nominal interest rate is 3%, and there is no expected change in future exchange rates, then as the spot exchange rate depreciates:

Accepted Answer

A)  the foreign return rises. 
B)  the foreign return falls. 
C)  the domestic return rises. 
D)  the domestic return falls. 
A)  the foreign return rises. 
B)  the foreign return falls. 
C)  the domestic return rises. 
D)  the domestic return falls.

Question 19

If UIP holds, the foreign interest rate is 10%, and the home currency is expected to depreciate by 4%, then the home interest rate is:

Accepted Answer

A)  4%. 
B)  6%. 
C)  10%. 
D)  14%. 
A)  4%. 
B)  6%. 
C)  10%. 
D)  14%.

Question 20

If UIP holds, the foreign interest rate is 6%, and the home currency is expected to appreciate by 2%, then the home interest rate is:

Accepted Answer

A)  10%. 
B)  8%. 
C)  4%. 
D)  3%. 
A)  10%. 
B)  8%. 
C)  4%. 
D)  3%.

Exam 15: Exchange Rates II: the Asset Approach in the Short Run

Why would lowering its own interest rates affect a nation's exchange rate?

Menu costs are the:

If the U.S. interest rate is 9% and the Eurozone interest rate is 5%, then in the short run we would expect:

(Figure: The Domestic Interest Rate) Using the graph, if the dollar rate of interest increases from 5% to 7%, what result will occur in the short run?

A country with a fixed exchange rate faces:

In the short run, the chain of causality between monetary policy and the exchange rate under fixed rates differs from a floating rate. How?

What are the consequences for a nation that keeps its exchange rate fixed, holds its own domestic interest rates below market to encourage domestic spending, and allows free foreign investment?

The dependent variable (vertical axis) in standard graphical treatments of the money market is:

Suppose domestic interest rates are at 4.55%, while foreign returns are bringing 6.38%. According to the asset approach, if the expected future exchange rate is three dollars per unit of foreign currency, what can we say about the current spot rate if UIP holds?

Assuming sticky prices and given expectations of future exchange rates, what is the short-run effect on the exchange rate of the U.S. dollar (purchasing euros) and on domestic and foreign rates of return if there is a temporary increase in the quantity of U.S. dollars?

From full long-run equilibrium, expectations of future exchange rates can only change when there is a:

If UIP holds, the interest rate at home is 4%, and the exchange rate is expected to depreciate by 3%, then the foreign interest rate is:

Two currencies existed in Iraq before the U.S. invasion and subsequent conflict. What lessons are there for students of exchange rates?

The behavior of exchange rates during the period 1999-2004 ____ predictable based on the short run asset model if we assume that changes in the money supply were assumed to be _________.

A key assumption to ensure that domestic returns and foreign returns are in equilibrium is:

Explain why an increase in the European interest rate increases the dollar-euro exchange rate.

If Bulgaria, for instance, wished to keep its exchange rate with the dollar fixed, what monetary policy options are available to lower unemployment in the short run?

If the domestic dollar return (home nominal interest rate) is 5%, and the foreign nominal interest rate is 3%, and there is no expected change in future exchange rates, then as the spot exchange rate depreciates:

If UIP holds, the foreign interest rate is 10%, and the home currency is expected to depreciate by 4%, then the home interest rate is:

If UIP holds, the foreign interest rate is 6%, and the home currency is expected to appreciate by 2%, then the home interest rate is:

Trade in the Global Economy

Trade and Technology: The Ricardian Model

Gains and Losses From Trade in the Specific-Factors Model

Trade and Resources: the Heckscher-Ohlin Model

Movement of Labor and Capital Between Countries

Increasing Returns to Scale and Monopolistic Competition

Offshoring of Goods and Services

Import Tariffs and Quotas Under Perfect Competition

Import Tariffs and Quotas Under Imperfect Competition

Export Subsidies in Agriculture and High-Technology Industries

International Agreements: Trade, Labor, and the Environment

The Global Macroeconomy

Introduction to Exchange Rates and the Foreign Exchange Market

Exchange Rates I: the Monetary Approach in the Long Run

National and International Accounts: Income, Wealth, and the Balance of Payments

Balance of Payments I: the Gains From Financial Globalization

Balance of Payments II: Output, Exchange Rates, and Macroeconomic Policies in the Short Run

Fixed Versus Floating: International Monetary Experience

Exchange Rate Crises: How Pegs Work and How They Break

The Euro

Topics in International Macroeconomics

Filters

The behavior of exchange rates during the period 1999-2004 predictable based on the short run asset model if we assume that changes in the money supply were assumed to be _____.