Deck 15: Exchange Rates in the Long Run

Question 1

For which of the following will the law of one price hold best?

A)shirt
B)butter
C)gold
D)milk

Answer 1

C

Question 2

If American and Japanese consumers buy the same basket of goods in each country and there is no inflation in either country,

A)the law of one price will hold.
B)deviations from PPP will occur.
C)PPP will hold.
D)Both A and C.

Answer 2

D

Question 3

Over a short-run period (i.e.,week or month),________ dominate exchange rate movements.

A)short-run inflation differentials
B)nominal price changes
C)relative price changes
D)None of the above

Answer 3

C

Question 4

PPP holds better for ________ countries.

A)low-inflation
B)poor
C)rich
D)high-inflation

Question 5

Evidence suggests that,following some exogenous shock,exchange rates change

A)before prices change.
B)after prices change.
C)at the same time prices change.
D)None of the above.

Question 6

We expect PPP to hold better

A)for annual data than monthly data.
B)for high-inflation countries.
C)in the long run.
D)All of the above.

Question 7

Deviations from PPP

A)may be due to the differential speed of adjustment between exchange rates and prices.
B)may occur when international trade involves lags between order and delivery.
C)may appear during periods dominated by news or unexpected events.
D)All of the above.

Question 8

The domestic currency is said to be ________ if it has appreciated at a lower rate than the difference between the domestic inflation rate and the higher foreign inflation rate.

A)undervalued
B)overvalued
C)appreciated
D)risky

Question 9

Changes in exchange rates are due to

A)real events only.
B)nominal events only.
C)both real and nominal events.
D)None of the above.

Question 10

Relative PPP indicates that

A)the exchange rate between any two currencies is equal to the ratio of their price indexes.
B)the same good sells for the same price internationally.
C)the percentage change in the exchange rate is equal to the inflation differential between the domestic and foreign country.
D)relative prices determine exchange rates.

Question 11

We can expect deviations from PPP because of

A)quotas and tariffs.
B)transportation costs.
C)differentiated goods.
D)All of the above.

Question 12

In the long run,________ dominate exchange rate movements.

A)short-run inflation differentials
B)long-run inflation differentials
C)short-run relative price changes
D)All of the above

Question 13

If the exchange rate is equal to the ratio of the domestic and foreign price indexes,

A)absolute PPP holds.
B)relative PPP holds.
C)one currency is said to be overvalued.
D)one currency is said to be undervalued.

Question 14

Which of the following statements is correct?

A)PPP is a theory of exchange rate determination.
B)Inflation differentials cause changes in exchange rates.
C)PPP is an equilibrium relationship between two endogenous variables.
D)PPP, or the law of one price, should hold well for individual goods.

Question 15

The law of one price should hold well for

A)differentiated products.
B)any individual goods traded internationally.
C)homogeneous goods.
D)All of the above.

Question 16

Which of the following is incorrect?

A)Exchange rates in the short run are much more variable than inflation differentials.
B)Deviations from PPP are much more apparent for monthly data than annual.
C)PPP holds best in the long run.
D)None of the above.

Question 17

Relative price changes indicate

A)all prices move together.
B)all exchange rates move together.
C)some prices increase faster than others.
D)exchange rates appreciate faster than prices change.

Question 18

If the dollar appreciates against the Canadian dollar at a faster rate than the Canadian inflation rate exceeds the U.S.rate,then the U.S.dollar appears

A)depreciated.
B)overvalued.
C)undervalued.
D)None of the above.

Question 19

Arbitrage operations can be executed

A)in foreign exchange markets.
B)in goods markets.
C)Both A and B.
D)None of the above.

Question 20

If absolute PPP held,then the real exchange rate must be equal to

A)a constant.
B)one.
C)zero.
D)a positive number.

Question 21

According to The Economist magazine's Big Mac index,one of the most overvalued currencies as of July 2008 was the Norwegian kroner.Which of the following is a likely implication of that fact?

A)That goods and services are more expensive in Norway than in the U.S.
B)That the Norwegian currency is going to be undervalued in the near future.
C)That the Norwegian currency is likely to appreciate in the near future.
D)That the Norwegian government is running a large deficit.

Question 22

In economics,what does CPI stand for?

A)Continuous Price Inflation.
B)Central Price Information.
C)Consumer Price Index.
D)Collateral Price Inflation.

Question 23

Changes in relative prices occur when

A)all prices move together.
B)all exchange rates move together.
C)product prices change at different rates.
D)exchange rate appreciation is greater than price appreciation.

Question 24

We expect that in the long run,exchange rate movements will largely reflect inflation differentials.

Question 25

If the price of Big Mac is $3.61 in the U.S.and 3.405 € in France,and PPP holds,what is the value of the euro in dollars that is implied by The Economist magazine's Big Mac index?

A)$1.060
B)$0.943
C)$1.943
D)None of the above.

Question 26

For which of the following is the law of one price least likely to hold?

A)Haircuts
B)Gold
C)US Treasury Bonds
D)Petroleum

Question 27

Which of the following is correct?

A)Exchange rates in the short run are much more variable than inflation differentials.
B)Deviations from PPP are much more apparent for monthly data than annual.
C)PPP holds best in the long run.
D)All of the above.

Question 28

The empirical data indicate that in the short run exchange rates are much more variable than inflation differentials.

Question 29

The higher the inflation differential between countries,the less likely it is that relative PPP will hold.

Question 30

PPP holds better for low-inflation countries.

Question 31

If relative PPP held,then the real exchange rate must be equal to one.

Question 32

If absolute PPP holds,then the real exchange rate must equal 1.

Question 33

The more homogeneous goods are,the more we expect the law of one price to hold.

Question 34

Suppose a year ago the exchange rate between Mexican pesos and dollars was 13.5 pesos per dollar,and that according to relative PPP the exchange rate was in equilibrium.Furthermore,assume that since then,Mexican inflation has been 12 percent while the U.S.inflation has been 3 percent.If according to relative PPP the peso is now said to be overvalued,what is a possible exchange rate consistent with this assertion?

A)13.5 pesos per dollar.
B)14.72 pesos per dollar.
C)15 pesos per dollar.
D)20 pesos per dollar.

Question 35

Studies of PPP covering many years will be more likely to yield evidence of PPP than studies based on short-run data.

Question 36

If absolute PPP holds,then relative PPP will also hold.

Question 37

The only reason that exchange rates change is because overall price levels in the countries change.

Question 38

PPP is a theory of real exchange rate determination.

Question 39

Endogenous variables tend to be less volatile than exogenous ones.

Question 40

If the law of one price holds for a single good,then absolute PPP measured with price indexes will also hold.

Question 41

Empirical studies find that exchange rates are much more variable than inflation differentials. How can we explain this empirical result?

Question 42

What are the main reasons for deviations from PPP? Give,at least,5 reasons with a short explanation.

Question 43

What is the difference between endogenous and exogenous variables? In the equilibrium condition of PPP,which variables are endogenous and which are exogenous?

Question 44

Is relative PPP a useful equilibrium concept for describing general trends in exchange rates? Under what kinds of circumstances would the concepts of PPP be best applied?

Question 45

Explain briefly what an "overvalued" currency is. Would you change your explanation depending upon whether or not there is central bank intervention or not? Discuss.

Question 46

The establishment of the Euro as a unit of account in 1999 meant that from then on the currencies of the participating countries traded at a fixed rate,until the Euro completely replaced these currencies in the year 2002.
(a) How would the inflation rates of these countries have to had been in these transition years for PPP to hold?
(b)If the inflation of Italy was twice as high as that of Germany a year between 1999 and 2002,what can we say then about the Italian lira against the German mark?
(c)What does the concept of PPP thus tells us about what needs to happen for such this monetary agreement to work for a long period of time?

Question 47

Is PPP a theory of exchange rate determination? Explain why or why not?

Question 48

Briefly explain the difference between absolute and relative PPP.

Question 49

Suppose that you desperately need a grade of "A" from your International Finance course and further suppose that it depends upon the grade that you will get from the term paper that you write on PPP. Let's assume that you know that your teacher believes that PPP holds anytime anywhere. What kind of evidence would you submit that would indicate that PPP holds? In other words,what kind of countries and data would you choose for your analysis to bias the empirical results regarding PPP?