Deck 26: Economic Policy in the Open Economy Under Flexible Exchange Rates

Question 1

Under a flexible exchange rate system, changes in the foreign rate of interest will affect both the financial markets and the real sector. Explain why this comes about using the IS/LM/BP model. What influence, if any, does the degree of international capital mobility have on the results?

Answer 1

not answered

Question 2

In the diagram below, under flexible exchange rates, this country has an incipient
Balance-of-payments (official reserve transactions) __________; as a consequence, the
BP curve will shift __________.

A) surplus; upward and to the left
B) surplus; downward and to the right
C) deficit; upward and to the left
D) deficit; downward and to the right

Answer 2

D

Question 3

Explain, in the IS/LM/BP framework with flexible exchange rates, the impact of an autonomous increase in foreign demand for a country's exports upon the country's national income, money supply, and exchange rate. If there is no impact on a variable, explain why.

Answer 3

B.

Question 4

If capital is imperfectly mobile (with BP flatter than LM), explain why governments find fiscal policy less effective under flexible rates compared to fixed rates. Is fiscal policy ever completely ineffective? If so, under what conditions? If not, why not?

Question 5

In a situation of flexible exchange rates, an exogenous increase in foreign interest rates will cause __________ of the domestic currency and, most likely, a __________ in the domestic interest rate.

A) a depreciation; a rise
B) an appreciation; a rise
C) a depreciation; a fall
D) an appreciation; a fall

Question 6

The IS/LM/BP analysis suggests that, if the BP curve is flatter than the LM curve and the exchange rate is flexible, expansionary fiscal policy will lead to __________ of the
Country's currency, which will make the fiscal policy __________ effective in influencing
National income than if the country had a fixed exchange rate.

A) a depreciation; more
B) a depreciation; less
C) an appreciation
D) an appreciation; less

Question 7

Under flexible exchange rates, expansionary fiscal policy is less likely to lead to crowding out of investment and more likely to penalize the foreign sector than under fixed rates. Agree? Disagree? Explain.

Question 8

It appears that the world is becoming more financially interdependent. How might you incorporate this change, if necessary, in the IS/LM/BP model? What are the implications of this change for macro policy in general and fiscal policy in particular?

Question 9

Explain, using the IS/LM/BP model, how an increase in foreign interest rates can lead to an increase in domestic interest rates.

Question 10

In a situation of flexible exchange rates, other things equal, a shift of the IS curve to the left will lead to __________ of the country's currency if the BP curve is steeper than the LM curve and __________ of the country's currency if the LM curve is steeper than The BP curve.

A) an appreciation; also will lead to an appreciation
B) an appreciation; will lead to a depreciation
C) a depreciation; will lead to an appreciation
D) a depreciation; also will lead to a depreciation

Question 11

In a situation of flexible exchange rates and where the BP curve is steeper than the LM curve,

A) monetary policy is less effective in raising national income than would be the case
Under fixed exchange rates.
B) expansionary fiscal policy will be more effective in raising the level of national
Income than would be the case under fixed exchange rates.
C) expansionary fiscal policy will lead to an appreciation of the country's currency.
D) the BP curve stays fixed in the same position irrespective of any shifts that occur in
The IS and LM curves.

Question 12

The IS/LM/BP analysis suggests that, under flexible exchange rates,

A) monetary policy is less powerful for affecting national income than under fixed
Exchange rates.
B) a country may have difficulty in staying on the LM curve.
C) expansionary fiscal policy, in theory, may cause either depreciation or appreciation of
The home currency.
D) expansionary fiscal policy will always lead to a decline in national income.

Question 13

In the situation in Question #13 above, during exchange-rate adjustment process that takes place due to the incipient imbalance in the external sector,

A) the BP curve will shift to the left (or vertically upward).
B) the IS curve will shift to the right (or vertically upward).
C) the LM curve will shift to the right (or vertically downward).
D) the LM curve will shift to the left (or vertically upward).

Question 14

In the IS/LM/BP analysis, as a country's currency depreciates (and assuming that the Marshall-Lerner conditions holds), the country's

A) LM curve shifts to the right.
B) BP curve shifts to the right.
C) IS curve shifts to the left.
D) LM curve shifts to the left.

Question 15

Under flexible exchange rates,

A) fiscal policy is most effective in influencing national income when capital is perfectly
Immobile internationally and least effective when capital is perfectly mobile
Internationally.
B) monetary policy is more effective in influencing national income when capital is
Perfectly immobile internationally than when capital is perfectly mobile
Internationally.
C) both fiscal policy and monetary policy are completely ineffective in influencing
National income when capital is perfectly immobile internationally.
D) fiscal policy has no effect on national income, regardless of what assumptions are
Made about the degree of international mobility of capital.

Question 16

Given the following diagram, with flexible exchange rates:

Assume that the economy is in domestic equilibrium. In this situation, there will be __________ in the country's balance of payments (official reserve transactions balance), with the consequence that the country's currency will __________ in the foreign exchange markets.

A) an incipient deficit; depreciate
B) an incipient deficit; appreciate
C) an incipient surplus; depreciate
D) an incipient surplus; appreciate

Question 17

Suppose that country A with a flexible exchange rate undertakes expansionary monetary Policy. Especially if short-term funds are extremely mobile between countries, A's Currency will tend to __________ because of this policy, and this result suggests that A's Monetary policy will be __________ effective in influencing national income than if A Had a fixed exchange rate rather than a flexible exchange rate.

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

Question 18

The movement to more flexible exchange rates has made it necessary to more fully coordinate the use of monetary and fiscal policy. Explain why this is so, using the IS/LM/BP model, an income target, and an interest rate target.

Question 19

If, other things equal, a country with a flexible exchange rate decreases its money supply, this will lead to __________ in the value of the country's currency, which will tend to
__________ the country's national income.

A) a depreciation; increase
B) a depreciation; decrease

Question 20

Under a flexible-rate system, when the BP curve is flatter than the LM curve, an
Autonomous increase in foreign interest rates will have what impacts on the domestic
Interest rate and domestic national income?

A) domestic interest rate will increase, domestic national income will decrease
B) domestic interest rate will increase, domestic national income will not change
C) domestic interest rate will increase, domestic national income will increase
D) domestic interest rate will not change, domestic national income will decrease

Question 21

The IS/LM/BP analysis suggests that, if the BP curve is steeper than the LM curve and
The exchange rate is flexible, contractionary fiscal policy by country A will lead to
__________ in country A's balance of payments and hence to __________ of A's
Currency relative to other currencies.

A) an incipient deficit; an appreciation
B) an incipient deficit; a depreciation
C) an incipient surplus; an appreciation
D) an incipient surplus; a depreciation

Question 22

The effectiveness of monetary policy in influencing national income will, under a system of fixed exchange rates, be __________ under a system of flexible exchange rates.

A) greater than
B) less than
C) perhaps greater than; perhaps less than
D) the same as

Question 23

With perfect capital mobility and other things equal, an exogenous increase in demand for a country's exports will lead to __________ increase in the country's national income under fixed exchange rates than under flexible exchange rates.

A) a greater
B) a smaller
C) the same
D) a greater, a smaller, or the same - cannot be determined without more information

Question 24

In the view of economists, which one of the following statements is true?

A) Fiscal policy is unambiguously more effective in influencing national income under
Flexible exchange rates than under fixed exchange rates.
B) Fiscal policy is unambiguously more effective in influencing national income under
Fixed exchange rates than under flexible exchange rates.
C) Monetary policy is unambiguously more effective in influencing national income
Under flexible exchange rates than under fixed exchange rates.
D) Monetary policy is unambiguously more effective in influencing national income
Under fixed exchange rates than under flexible exchange rates.

Question 25

If we consider a situation of expansionary monetary policy under flexible exchange rates, the monetary expansion will lead to __________ of the home currency and thus will be
__________ effective in increasing national income than under fixed exchange rates.

A) an appreciation; more
B) an appreciation; less
C) a depreciation; more
D) a depreciation; less

Question 26

If a country's BP curve is upward-sloping (i.e., it is neither vertical nor horizontal), then
An intersection of the country's IS and LM curves at a point above the BP curve will be
Associated with __________ in the country's balance of payments. With flexible
Exchange rates, the country's BP curve will consequently shift __________.

A) an incipient deficit; upward and to the left
B) an incipient deficit; downward and to the right
C) an incipient surplus; upward and to the left
D) an incipient surplus; downward and to the right

Question 27

If, in the IS/LM/BP diagram in a situation where short-term capital is imperfectly mobile Internationally and a flexible exchange rate system exists, an incipient balance-of- Payments (official reserve transactions) surplus will cause the BP curve to shift__________ and the IS curve to shift __________.

A) upward and to the left; downward and to the left
B) upward and to the left; upward and to the right
C) downward and to the right; downward and to the left
D) downward and to the right; upward and to the right