Deck 28: Fixed or Flexible Exchange Rates

Question 1

If virtually all speculators buy a currency just before what would be the cyclical low points in the currency's value without speculative activity, this speculation is likely to be__________ with respect to its impact on the amplitude of the cycle; if the speculators Sell the currency just before what would otherwise be the high values of the currency During its fluctuations, this speculation __________ in its impact on the amplitude of the Cycle..

A) destabilizing; also is likely to be destabilizing
B) destabilizing; is likely to be stabilizing
C) stabilizing; is likely to be destabilizing
D) stabilizing; also is likely to be stabilizing

Answer 1

stabilizing; also is likely to be stabilizing

Question 2

The optimal size of international reserves occurs for a country at the point where the

A) total benefit of holding the reserves equals the total cost of holding the reserves.
B) marginal benefit of holding the reserves exceeds the marginal cost of holding the
Reserves by the greatest amount.
C) marginal benefit of holding the reserves equals the marginal cost of holding the reserves.
D) marginal cost of holding the reserves is zero.

Answer 2

C

Question 3

In comparing the size of central bank reserves relative to world imports in the 1948-1972
Period (a relatively fixed exchange rate period) with the same ratio from 1973 onward (a
Relatively flexible exchange rate period), the ratio has been __________ in the more
Recent period. This result __________ consistent with the theoretical expectation of
Economists.

A) smaller; is not
B) smaller; is
C) larger; is not
D) larger; is

Answer 3

B

Question 4

Present the argument that the adoption of flexible rates would lead to a removal of restrictions on trade. Do you agree that these controls would be eliminated? Does the adoption of flexible rates undermine all the reasons for seeking protection that were covered in the trade policy section of this course? Explain.

Question 5

Using the IS/LM/BP framework, explain how two of the following shocks impact on the domestic economy under flexible exchange rates and under fixed exchange rates.
(a) an increase in the foreign rate of interest
(b) a decrease in foreign income
(c) a decrease in foreign prices

Question 6

If a country adopts a currency board arrangement, a result is that the country's money supply __________ be increased by the purchase of domestic assets from the country's citizens by the country's central bank; in this arrangement, the country's money supply
__________ be increased by the purchase of foreign assets from the country's citizens by the country's central bank.

A) can; also can
B) can; cannot
C) cannot; can
D) cannot; also cannot

Question 7

In a situation of imperfect short-term capital mobility between countries, if the BP curve Is flatter than the LM curve for country A, then an internal real sector shock in country A (such as an autonomous increase in real investment spending) will have a __________ Impact on A's national income under fixed exchange rates than under flexible exchange Rates; if the BP curve is steeper than the LM curve for country A, then that internal real Sector shock __________ impact on A's income under fixed exchange rates than under Flexible exchange rates.

A) larger; will have a smaller
B) larger; will also have a larger
C) smaller; will also have a smaller
D) smaller; will have a larger

Question 8

What case could be made for a wider "band" of permitted exchange rate changes of the home currency against some foreign currencies (say 15 percent) than against some other foreign
currencies (say 10 percent)? What case could be made against this difference in width of permitted variations? Explain.

Question 9

Describe the features of a currency board arrangement. Then indicate general conditions under which the adoption of a currency board by a country would be desirable for the country.

Question 10

If an important oil exporter such as Saudi Arabia were successful in raising the price of petroleum in the next few weeks, would a flexible exchange rate or a fixed exchange rate for the United States be better for mitigating the negative economic impact upon the United States? Why?

Question 11

A major advantage of the system of flexible exchange rates (as opposed to fixed exchange rates) is commonly thought to be

A) the likelihood that external monetary shocks will not influence domestic national
Income under flexible exchange rates.
B) the strong possibility that the greater exchange rate risk under flexible rates will
Increase the volume of international trade.
C) the enhanced effectiveness of monetary policy in influencing national income under
Flexible exchange rates.
D) the "virtuous circle" that flexible rates can bring between depreciation and inflation.

Question 12

A situation where a country announces a parity value for its currency and permits small variations around that value, but also adjusts the parity regularly by small amounts according to various indicators, is known as

A) a dirty float.
B) a crawling peg.
C) a managed float strategy of "leaning against the wind."
D) a "wider band."

Question 13

In view of the theory of optimum currency areas, a country would be a good candidate for membership in such an area if it had a __________ degree of factor mobility with other potential member countries of the currency area and if the country were a relatively__________ economy.

A) low; closed
B) low; open
C) high; closed
D) high; open

Question 14

If a country's BP curve is flatter than its LM curve, then an external financial shock of a rise in interest rates abroad would, under flexible exchange rates, lead to __________ in
The home country's national income. If exchange rates were fixed, this external financial shock would __________ in the home country's national income.

A) a decrease; lead to an increase
B) a decrease; also lead to a decrease
C) an increase; also lead to an increase
D) an increase; lead to a decrease

Question 15

How could exchange rate protection of, for example, 10 percent, be duplicated in its effects across export and import-substitute industries by using tariffs and subsidies instead? Explain. Suppose that you are a firm in an import-substitute industry that is currently receiving less protection than most other import-substitute industries. Would you be in favor of scrapping the existing protection framework and adoption of exchange rate protection as an alternative policy? Explain.

Question 16

Proponents of fixed exchange rates would find the most support for their position in which one of the following empirical results regarding the relationship between
Exchange rate variations and the volume of international trade? (Assume that the empirical tests adequately account for other factors that influence the volume of trade.)

A) no discernible relationship between exchange rate variations and the volume of trade
B) a negative relationship between exchange rate variations and the volume of trade
C) a mildly positive relationship between exchange rate variations and the volume of Trade
D) a strongly positive relationship between exchange rate variations and the volume of Trade

Question 17

The IS/LM/BP analysis suggests that an external real sector shock, such as a rise in national income abroad will cause, under fixed exchange rates, a __________ shift in a
Home country's BP curve (assuming that short-term financial capital is not perfectly
Mobile), a __________ in the home country's balance of payments, and __________ in
The home country's national income.

A) rightward; surplus; an increase
B) rightward; deficit; a decrease
C) rightward; surplus; a decrease
D) leftward; deficit; a decrease

Question 18

Suppose that a currency plummets downward because of speculation against it. Can it necessarily be stated that this speculation is "destabilizing" in nature? Why or why not?

Question 19

In theory, business cycles are __________ likely to be transmitted from one country to another under a system of fixed exchange rates than under a system of flexible exchange rates. It is also a generally-accepted theoretical result by economists that monetary policy is __________ useful for dampening business cycle activity under a system of fixed exchange rates than under a system of flexible exchange rates.

A) more; more
B) more; less
C) less; more
D) less; less

Question 20

Explain why it is alleged that a system of flexible exchange rates could have "wasteful resource movements." Why are these movements thought to be wasteful? Don't resources need to move between sectors as demand, cost, and profitability conditions change in a dynamic economy?

Question 21

If a country has a currency board arrangement (with a 100 percent reserve system) in
Place, then the country's money supply can be increased by a __________ by the
Country's central bank.

A) purchase of domestic assets from domestic citizens.
B) purchase of foreign (external) assets from domestic citizens.
C) sale of domestic assets to domestic citizens.
D) sale of foreign (external) assets to domestic citizens.

Question 22

Other things equal, a domestic monetary or financial shock (a shift in the LM curve)
Tends to produce what relative degree of GDP change for the home country under a
Situation of flexible exchange rates compared to a situation of fixed exchange rates?

A) smaller change with flexible rates
B) same change with flexible rates as with fixed rates
C) larger change with flexible rates
D) smaller, same, or larger change with flexible rates - cannot be determined without more information

Question 23

The view that inflation in a country can lead to depreciation of the country's currency which in turn can cause further inflation is known as

A) the vicious circle hypothesis.
B) the autonomous spending multiplier concept.
C) the purchasing power parity problem.
D) the exchange risk hypothesis.

Question 24

Which one of the following is NOT an alleged disadvantage of a flexible exchange rate system?

A) possibility of destabilizing speculation
B) wasteful resource movements between industries
C) increased need for international reserves
D) danger of a "vicious circle" between inflation in a country and depreciation of that Country's currency

Question 25

A "crawling peg" arrangement

A) has currently been adopted by a majority of the member of the International Monetary
Fund.
B) relies on a set of indicators, such as size of a country's international reserves, to
Trigger changes in the parity value of the country's currency.
C) has been adopted by fewer than five members of the International Monetary Fund.
D) usually permits very wide variations of the country's currency around the parity value