Deck 18: Fixed Exchange Rates and Foreign Exchange Intervention

Question 1

A balance sheet for the central bank of Pecunia is shown below:
Central Bank Balance Sheet
AssetsLiabilities
Foreign assets $1,000Deposits held by private banks $500
Domestic assets $1,500Currency in circulation$2,000
Please write the new balance sheet if the bank purchased $100 in foreign bonds by writing a check on itself.

Answer 1

Central Bank Balance Sheet
Assets Liabilities
Foreign assets $1,100 Deposits held by private banks $600
Domestic assets $1,500 Currency in circulation $2,000

Question 2

Please define and give an example of sterilized foreign exchange intervention.

Answer 2

Sterilized foreign exchange intervention occurs when a central bank carries out equal foreign and domestic asset transactions in opposite directions to nullify the impact on the domestic money supply. An example is a central bank purchasing $100 of domestic assets but selling $100 of foreign bonds.

Question 3

If the central bank does not purchase foreign assets when output increases but instead holds the money stock constant, can it still keep the exchange rate fixed at ?
Please explain.

Answer 3

No, the rise in output leads to an excess demand for money. If the central bank does not increase supply to meet this demand, the domestic interest rate would rise above the foreign rate, R*. This higher rate of return (and given expectations in the foreign exchange market) would cause the exchange rate to fall below .

Question 4

The liabilities side of a central bank's accounts consists of

A) deposits held by private banks.
B) currency in circulation.
C) deposits held by private banks and currency in circulation.
D) deposits held by foreign banks, domestic assets, and currency in circulation.
E) foreign assets and domestic assets.

Question 5

Which one of the following statements is most correct?

A) Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline.
B) Any central bank purchase of assets results in an increase in the domestic money supply, while any central bank sale of assets causes the money supply to decline.
C) Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline.
D) Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to increase.
E) Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets does not necessarily affect the money supply.

Question 6

Under fixed exchange rate, in general which one of the following statements is the MOST accurate?

A) The following condition should hold for domestic money market equilibrium: Mˢ/P = L(R*, Y).
B) The following condition should hold for domestic money market equilibrium: Mᵈ/P = L(R*, Y).
C) The following condition should hold for domestic money market equilibrium: Mˢ = L(R*, Y).
D) The following condition should hold for domestic money market equilibrium: P = L(R*, Y).
E) The following condition should hold for domestic money market equilibrium: R*Mᵈ/P = L(Y).

Question 7

Which one of the following statements is the MOST accurate?

A) Under a fixed exchange rate, central bank monetary tools are powerless to affect the economy's money supply.
B) Under a flexible exchange rate, central bank monetary tools are powerless to affect the economy's money supply or its output.
C) Under a fixed exchange rate, fiscal policy tools are powerless to affect the economy's money supply or its output.
D) Under a fixed exchange rate, central bank monetary tools are powerless to affect the economy's money supply or its output.
E) Under a dirty float exchange rate, central bank monetary tools are powerless to affect the economy's money supply or its output.

Question 8

Central banks often intervene in currency markets. This activity is called

A) super-pegging.
B) flexible floating.
C) currency warfare.
D) fixing exchange rates.
E) managed floating.

Question 9

A balance sheet for the central bank of Pecunia is shown below:
Central Bank Balance Sheet
AssetsLiabilities
Foreign assets $1,000Deposits held by private banks $500
Domestic assets $1,500Currency in circulation $2,000
Please write the new balance sheet if the bank sells $100 worth of foreign bonds for domestic currency.

Question 10

A balance sheet for the central bank of Pecunia is shown below:
Central Bank Balance Sheet
AssetsLiabilities
Foreign assets $1,000Deposits held by private banks $500
Domestic assets $1,500Currency in circulation$2,000
Please write the new balance sheet if the bank makes a sterilized transaction by selling $100 of foreign assets for domestic currency and then purchasing $100 of domestic assets by writing a check on itself.

Question 11

What are the factors affecting the demand for foreign currency?

Question 12

A system of managed floating exchange rates is

A) a system in which governments may attempt to moderate exchange rate movements without keeping exchange rates rigidly fixed.
B) a system in which governments use flexible exchange rates.
C) a system in which governments are forbidden from attempts to moderate exchange rate movements without keeping exchange rates rigidly fixed.
D) a system in which governments need to reach a prior agreement among them before they may attempt to moderate exchange rate movements without keeping exchange rates rigidly fixed.
E) a system in which governments use extensive fiscal policy to discourage exchange rate movements.

Question 13

Under fixed exchange rate, in general

A) the domestic and foreign interest rates are equal, R = R*.
B) R = R + (Eᵉ - E)/E.
C) the foreign and domestic interest rates are unequal.
D) the expected rate of domestic currency depreciation is high.
E) the expected rate of currency depreciation is one.

Question 14

Which one of the following statements is the most correct?

A) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign assets implies an increased home money supply.
B) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign assets implies a decreased home money supply.
C) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign assets implies an increased home money demand.
D) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated decrease in the home central bank's foreign assets implies an increased home money supply.
E) If central banks are not sterilizing and the home country has a balance of payments shortage, any associated decrease in the home central bank's foreign assets implies an increased home money supply.

Question 15

A central bank's international reserves consists of its holdings of

A) gold.
B) silver and gold.
C) foreign assets and gold.
D) domestic assets and precious metals.
E) foreign and domestic currency holdings.

Question 16

Which one of the following statements is most correct?

A) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in a foreign central bank's claims on the home country implies a decreased foreign money supply.
B) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated decrease in a foreign central bank's claims on the home country implies a decreased foreign money demand.
C) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated decrease in a foreign central bank's claims on the home country implies a decreased foreign money supply.
D) If central banks are not sterilizing and the home country has a balance of payments shortage, any associated decrease in a foreign central bank's claims on the home country implies a decreased foreign money supply.
E) If central banks are not sterilizing and the home country has a balance of payments shortage, any associated decrease in a foreign central bank's claims on the home country implies an increased domestic money supply.

Question 17

Industrialized countries typically ________ their floating exchange rates. Developing countries often ________ their floating exchange rates.

A) fix; allow markets to determine
B) manage; peg
C) allow markets to determine; fix
D) fix; manage
E) peg; manage

Question 18

Why is it important to understand fixed exchange rates in the modern global economy?

Question 19

What is the expected dollar rate of return on dollar deposits if today's exchange rate is $1.10 per euro, next year's expected exchange rate is $1.165 per euro, the dollar interest rate is 10%, and the euro interest rate is 5%?

A) 10%
B) 11%
C) -1%
D) 0%
E) 5%

Question 20

Which of the following is an example of a regional currency arrangement?

A) most-favored nation status
B) free-trade zones
C) exchange rate union
D) currency cartel associations
E) agreement on commercial trade

Question 21

Which one of the following statements is the MOST accurate?

A) Appreciation is a rise in E when the exchange rate floats while revaluation is a fall in E when the exchange rate is fixed.
B) Appreciation is a fall in E when the exchange rate floats while revaluation is a fall in E when the exchange rate is fixed.
C) Appreciation is a fall in E when the exchange rate is fixed while revaluation is a fall in E when the exchange rate is flexible.
D) Appreciation is a fall in E when the exchange rate floats while revaluation is a rise in E when the exchange rate is fixed.
E) Appreciation is a rise in E when the exchange rate floats while revaluation is a rise in E when the exchange rate is fixed.

Question 22

Which of the following best describes a deliberate government decision to lower the exchange rate, E?

A) appreciation
B) depreciation
C) revaluation
D) devaluation
E) accumulation

Question 23

When a country's currency is devalued

A) output decreases.
B) output increases and the money supply decreases.
C) the money supply decreases.
D) output decreases and the money supply increases.
E) both the output and the money supply increases.

Question 24

Fiscal expansion under fixed exchange rates will have what temporary effect?

A) the money supply will decrease
B) output will decrease
C) the exchange rate will increase
D) the exchange rate will decrease
E) there will be no effect

Question 25

Which one of the following statements is the MOST accurate?

A) Fiscal policy has the same effect on output under fixed and flexible exchange rate regimes.
B) Fiscal policy affects output more under fixed than under flexible exchange rate regimes.
C) Fiscal policy affects output less under fixed than under flexible exchange rate regimes.
D) Fiscal policy cannot affect output under fixed exchange rate but does affect output under flexible exchange rate regimes.
E) Fiscal policy can affect output under fixed exchange rate but does not affect output under flexible exchange rate regimes.

Question 26

Which one of the following statements is the MOST accurate?

A) Fiscal policy has the same effect on employment under fixed and flexible exchange rate regimes.
B) Fiscal policy affects employment less under fixed than under flexible exchange rate regimes.
C) Fiscal policy affects employment more under fixed than under flexible exchange rate regimes.
D) Fiscal policy cannot affect employment under fixed exchange rate but does affect output under flexible exchange rate regimes.
E) Fiscal policy can affect employment under fixed exchange rate regimes, but does not affect output under flexible exchange rate regimes.

Question 27

Please discuss the difference between the terms devaluation and depreciation.

Question 28

Under fixed rates, which one of the following statements is the MOST accurate?

A) Fiscal policy can affect output, employment and international reserves at the same time.
B) Fiscal policy can affect only employment.
C) Fiscal policy can affect only international reserves.
D) Fiscal policy can affect only output and employment.
E) Fiscal employment can affect only output and international reserves.

Question 29

Which one of the following statements is the MOST accurate?

A) A devaluation occurs when the central bank lowers the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank raises E.
B) A devaluation occurs when the central bank raises the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank lowers E.
C) Devaluation occurs when the domestic currency price of foreign currency, E, raises and a revaluation occurs when E is lowered.
D) A devaluation occurs when the central bank of the foreign country raises the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank of the foreign country lowers E.
E) A devaluation occurs when the central bank raises the foreign currency price of domestic currency, E, and a revaluation occurs when the central bank lowers E.

Question 30

Under fixed rates, which one of the following statements is the MOST accurate?

A) Monetary policy can affect only output.
B) Monetary policy can affect only employment.
C) Monetary policy can affect only international reserves.
D) Monetary policy can not affect international reserves.
E) Monetary policy can only affect money supply.

Question 31

The main reason(s) why governments sometimes choose to devalue their currencies is (are)

A) devaluation makes domestic goods more expensive in relation to foreign goods.
B) devaluation makes domestic services more expensive in relation to foreign services.
C) devaluation increases foreign reserves held by the central bank.
D) devaluation improves the current account and increases foreign reserves held by the central bank.
E) devaluation hurts foreign currencies.

Question 32

If the central bank does not purchase foreign assets when output increases but instead holds the money stock constant, can it still keep the exchange rate fixed at ?
Please explain with the aid of a figure.

Question 33

Which one of the following statements is the MOST accurate?

A) Depreciation is a rise in E when the exchange rate is fixed while devaluation is a rise in E when the exchange rate floats.
B) Depreciation is a decrease in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.
C) Depreciation is a rise in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.
D) Depreciation is a rise in E when the exchange rate floats while devaluation is a decrease in E when the exchange rate is fixed.
E) Depreciation is a fall in E when the exchange rate is fixed while devaluation is a fall in E when the exchange rate floats.

Question 34

Which one of the following statements is the MOST accurate?

A) Devaluation reflects a deliberate government decision.
B) Depreciation reflects a deliberate government decision.
C) Devaluation reflects a deliberate government decision while depreciation is an outcome of government actions and market forces acting together.
D) Depreciation reflects a deliberate government decision while devaluation is an outcome of government actions and market forces acting together.
E) Devaluation and depreciation have the same meaning and the same causes.

Question 35

Which one of the following statements is the MOST accurate?

A) Revaluation reflects an outcome of government actions and market forces acting together while appreciation reflects a deliberate government decision.
B) Revaluation reflects a deliberate government decision while appreciation is an outcome of government actions and market forces acting together.
C) Revaluation reflects a deliberate government decision while appreciation is an outcome of government actions.
D) Revaluation and appreciation have the same meaning and the same causes.
E) Appreciation reflects a deliberate government decision while revaluation is an outcome of government actions and market forces acting together.

Question 36

By fixing the exchange rate, the central bank gives up its ability to

A) adjust taxes.
B) increase government spending.
C) influence the economy through fiscal policy.
D) depreciate the domestic currency.
E) influence the economy through monetary policy.

Question 37

Use a figure to illustrate the ineffectiveness of monetary policy to spur on an economy under a fixed exchange rate.

Question 38

Under fixed exchange rates, which one of the following statements is the MOST accurate?

A) Devaluation causes a rise in output.
B) Devaluation causes a decrease in output.
C) Devaluation has no effect on output.
D) Devaluation causes a rise in output and a decrease in official reserves.
E) Devaluation causes a decrease in output and in official reserves.

Question 39

Under fixed exchange rates, which one of the following statements is the MOST accurate?

A) Devaluation causes a decrease in output, a decrease in official reserves, and a contraction of the money supply.
B) Devaluation causes a rise in output, a rise in official reserves, and an expansion of the money supply.
C) Devaluation causes a rise in output and a rise in official reserves.
D) Devaluation causes a rise in output and an expansion of the money supply.
E) Devaluation causes a rise in official reserves, and an expansion of the money supply.

Question 40

Under fixed exchange rates, which one of the following statements is the MOST accurate?

A) Devaluation causes a reduction of the money supply.
B) Devaluation has no effect on the stock of money.
C) Devaluation causes an expansion of the money supply.
D) Devaluation causes a reduction in output.
E) Devaluation causes a reduction in official reserves.

Question 41

The global financial crisis of 2007-2008 resulted in a(n) ________ of the Swiss franc as foreign currency flowed ________ the country. As a result, Swiss products became ________ competitive in world markets.

A) depreciation; out of; more
B) depreciation; into; more
C) appreciation; out of; less
D) depreciation; out of; less
E) appreciation; into; less

Question 42

The global financial crisis of 2007-2008 resulted in a(n) ________ of the Swiss franc. In 2011, the Swiss central bank intervened in order to cause a(n) ________ of the franc.

A) appreciation; appreciation
B) depreciation; depreciation
C) appreciation; revaluation
D) depreciation; appreciation
E) appreciation; depreciation

Question 43

Please describe in detail a self-fulfilling currency crisis.

Question 44

Describe the effect of the 2008-2009 global financial crisis on the Swiss franc and the central bank's efforts to respond to the resulting problems.

Question 45

This question concerns the mechanism of a reserve currency standard.
Two countries, X and Y, have two currencies, x and y, fixed to the reserve currency, the U.S. dollar. Suppose the exchange rate between x and the U.S. dollar is 3x per dollar. Suppose the exchange rate between y and the U.S. dollar is 5y per dollar. Explain (using numbers) the mechanism if the x-y exchange rate was 0.8 x per y.

Question 46

When domestic and foreign currency bonds are imperfect substitutes, the domestic interest rate (R) can be written as

A) R = R - (Eᵉ -E)/E + ρ.
B) R = R - (Eᵉ -E)/E.
C) R = R + (Eᵉ -E)/E + ρ.
D) R = R - (Eᵉ +E)/E + ρ.
E) R = R - (Eᵉ -E)ρ.

Question 47

In the interest rate parity condition with imperfect substitutes and a risk premium of ρ

A) an increased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.
B) a decreased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.
C) an increased stock of domestic government debt will reduce the difference between the expected returns on domestic and foreign currency bonds.
D) an increased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.
E) a decreased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.

Question 48

Assuming perfect asset substitutability, can sterilized intervention by the central bank be effective?
Please discuss.

Question 49

The expectation of future revaluation causes a balance of payments crisis marked by

A) a sharp rise in reserves and a fall in the home interest rate below the world interest rate.
B) a sharp fall in reserves and an even bigger fall in the home interest rate below the world interest rate.
C) a sharp fall in reserves and a rise in the home interest rate above the world interest rate.
D) a sharp rise in reserves and an even greater rise in the home interest rate above the world interest.
E) a sharp fall in reserves and an unchanged home interest rate.

Question 50

A balance of payments crisis is best described as

A) a sharp change in interest rates sparked by a change in expectations about the level of imports.
B) a sharp change in foreign reserves sparked by a change in expectations about the future exchange rate.
C) a sharp change in interest rates sparked by a change in expectations about the level of exports.
D) a sharp change in foreign reserves sparked by a change in expectations about the level of imports.
E) a sharp change in foreign reserves sparked by a change in expectations about domestic production.

Question 51

Imperfect asset substitutability assumes

A) the returns on foreign and domestic currency bonds are identical.
B) the returns on foreign and domestic currency are unrelated.
C) the risks of holding foreign and domestic currency are identical.
D) the risks of holding foreign and domestic currency are unrelated to returns.
E) the returns on foreign and domestic currency differ and are influenced by risk.

Question 52

This question concerns the mechanism of a reserve currency standard.
Two countries, X and Y, have two currencies, x and y, fixed to the reserve currency, the U.S. dollar. Suppose the exchange rate between x and the U.S. dollar is 3x per dollar. Suppose the exchange rate between y and the U.S. dollar is 5y per dollar. Explain (using numbers) the mechanism if the x-y exchange rate was 0.5 x per y.

Question 53

The interest parity condition can be written as

A) R = R - (Eᵉ -E)/E.
B) R = R + (Eᵉ -E)/E.
C) R = R² - (Eᵉ -E)/E.
D) R = R/(Eᵉ -E).
E) R = R + (Eᵉ +E)/E.

Question 54

The expectation of future devaluation causes a balance of payments crisis marked by

A) a sharp rise in reserves and a fall in the home interest rate below the world interest rate.
B) a sharp fall in reserves and an even bigger fall in the home interest rate below the world interest rate.
C) a sharp fall in reserves and a rise in the home interest rate above the world interest rate.
D) a sharp rise in reserves and an even greater rise in the home interest rate above the world interest.
E) a sharp rise in reserves and a rise in the home interest rate to the level of the world interest.

Question 55

Capital flight

A) increases reserves.
B) is never associated with the expectation of devaluation.
C) may undo expected devaluation.
D) reduces losses during a devaluation scare.
E) decreases reserves and may induce devaluation.

Question 56

Briefly describe two systems for fixing the exchange rates of all currencies against each other and the time periods in which they were used.

Question 57

The signaling effect of foreign exchange intervention

A) never has any effect on exchange rates.
B) can alter the market's view of exchange rates independent from the stance of monetary and fiscal policies.
C) cannot cause an immediate exchange rate change when bonds denominated in different currencies are perfect substitutes.
D) never leads to actual changes in monetary or fiscal policy.
E) can alter the market's view of future monetary policies and cause an immediate exchange rate change.

Question 58

Perfect asset substitutability is the assumption that

A) the foreign exchange market is in equilibrium only when expected returns on domestic assets are greater than returns on foreign currency bonds.
B) the foreign exchange market is in equilibrium only when expected returns on foreign currency bonds are greater than returns on domestic assets.
C) the foreign exchange market is in equilibrium only when expected returns on all assets are negative.
D) the foreign exchange market is in equilibrium only when expected returns on domestic assets are equal to returns on foreign currency bonds.
E) the foreign exchange market is in equilibrium only when domestic assets are risk-free.

Question 59

Currency crises may result from

A) central bank balance sheets with higher liabilities than assets.
B) political upheaval leading to lowering exports.
C) a reconfiguration of central bank balance sheets.
D) speculative attacks on the currency or central banks purchasing excessive amounts of government bonds.
E) depreciation of foreign reserves.

Question 60

Imperfect asset substitutability exists

A) when it is possible for the expected returns on two assets to be different.
B) when the expected returns on two assets are the same.
C) only when one asset is foreign and the other is domestic.
D) when there is risk in the foreign exchange market.
E) when assets are liquid.

Question 61

Briefly discuss the main advantage of the bimetallic standard over the gold standard.

Question 62

A balance of payments crises under fixed exchange rates occurs when

A) marginal returns on foreign exchange investments approach zero.
B) a country runs out of foreign reserves.
C) a country is in a liquidity trap.
D) forward currency markets undergo high volatility.
E) exports and imports expand beyond some point.

Question 63

From the Civil War up to 1914, the United States adhered to a

A) gold standard.
B) silver standard.
C) bimetallic standard.
D) bronze standard.
E) copper standard.

Question 64

From 1837 and up until the Civil War, the United States adhered to a

A) gold standard.
B) silver standard.
C) bimetallic standard.
D) bronze standard.
E) copper standard.

Question 65

Please briefly describe what is meant by a gold exchange standard.

Question 66

Balance of payments crises under fixed exchange rates occur because of

A) government policies that are inconsistent with fixed exchange rates.
B) punitive currency wars.
C) global inflation and trade imbalances due to war.
D) excessive exports and imports that overload the global system.
E) monotonic expansion in global currency volume.

Question 67

Describe the mechanism which would take place if the Bank of England decides to increase its money supply by purchasing domestic assets under the gold standard.

Question 68

List the drawbacks of the gold standard.

Question 69

Does the signalling effect of foreign exchange intervention support or refute the claim that assets cannot be perfect substitutes if sterilized intervention is going to have any effect?
Please explain.

Question 70

If assets are imperfect substitutes, then a decrease in the amount of domestic currency bonds held by the public will ________ the risk premium and ________ the amount of domestic currency bonds held by the central bank.

A) decrease; leave unchanged
B) increase; decrease
C) increase; increase
D) decrease; decrease
E) leave unchanged; decrease

Question 71

If assets are imperfect substitutes, then an increase in the amount of domestic currency bonds held by the public will ________ the risk premium and ________ the amount of domestic currency bonds held by the central bank.

A) increase; leave unchanged
B) increase; decrease
C) increase; increase
D) decrease; decrease
E) leave unchanged; decrease

Question 72

Explain how a country whose currency is the reserve currency can use monetary policy for macroeconomic stabilization. In particular, explain the result if that country doubled its domestic money supply.