Deck 14: Prices and Exchange Rates: Purchasing Power Parity

Question 1

Suppose that a central bank sells domestic currency to buy foreign assets to fix the exchange rate. To sterilize this intervention, the central bank will have to:

A) buy bonds in the open market operations to increase domestic money supply.
B) buy bonds in the open market operations to decrease domestic money supply.
C) sell bonds in the open market operations to increase domestic money supply.
D) sell bonds in the open market operations to decrease domestic money supply.

Answer 1

sell bonds in the open market operations to decrease domestic money supply.

Question 2

The monetary approach is derived from the assumptions) that:

A) money demand equals money supply.
B) money demand is a fixed proportion of the domestic price level times real income.
C) the law of one price holds.
D) All of the above are correct.

Answer 2

All of the above are correct.

Question 3

The basic premise of the monetary approach is that:

A) Exchange rate movements change according to uncontrolled shocks.
B) Holdings of international reserves should be minimized.
C) Any balance of payments disequilibrium is based on a monetary disequilibrium.
D) People's willingness to hold money can alter exchange rates but not the balance of payments.

Answer 3

Any balance of payments disequilibrium is based on a monetary disequilibrium.

Question 4

Sterilized intervention is the policy that:

A) targets a domestic inflation rate within a certain range of values.
B) attempts to influence exchange rate movements with official statements on the government's preferred rate, without taking any direct action in the financial markets.
C) coordinates monetary and fiscal policies with one's trading partners so as to achieve particular international economic outcomes.
D) offsets private capital movements with changes in the asset portfolio of the central bank.

Question 5

One key implication of the MABR is that expansionary monetary policy:

A) Always increases output.
B) Always decreases output.
C) Alters output in the short run, but not in the long run.
D) Does not alter output in the short run or the long run.

Question 6

Suppose that the U.S. Fed increases the money supply by 10%. Then under MAER:

A) The exchange rate dollar/foreign currency) rises by 10%
B) The exchange rate dollar/foreign currency) falls by 10%
C) Foreign inflation rises by 10%
D) Foreign inflation falls by 10%

Question 7

Currency plus commercial bank reserves held against deposits:

A) Base money
B) Temporary money
C) International credit
D) Domestic reserves

Question 8

If the U.S. income grows, then

A) U.S. money supply decreases
B) U.S. money supply increases
C) U.S. money demand decreases
D) U.S. money demand increases

Question 9

The MABP implies that the ________ equals to the foreign inflation rate plus the growth rate of domestic output minus the change in domestic money creation.

A) National interest rate
B) Holdings of gold
C) Change in exchange rates
D) Change in international reserves

Question 10

The MAER emphasizes money demand and money supply as determinants of:

A) The balance of payments under the fixed exchange rate.
B) The balance of payments under the floating exchange rate.
C) Exchange rate movements
D) Capital flows

Question 11

A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called

A) an unsterilized foreign exchange intervention.
B) a sterilized foreign exchange intervention.
C) a balance-of-payment exchange rate rule.
D) monetary neutrality.

Question 12

Under the flexible exchange rate, an increase in the foreign price level leads to a domestic currency __________.

A) appreciation
B) depreciation
C) devaluation
D) overshooting

Question 13

An unsterilized intervention in which a central bank sells domestic currency to buy foreign assets will lead to:

A) an increase in foreign reserves
B) a decrease in domestic money supply
C) an appreciation of domestic currency
D) All of the above are correct.

Question 14

Suppose the U.S. income grows by 4 percent. Under the MABR, which of the following percentage changes could offset this growth?

A) International reserves increase by 2 percent and foreign inflation rises by 2 percent
B) International reserves increase by 2 percent and foreign inflation falls by 2 percent
C) International reserves decrease by 2 percent and foreign inflation rises by 2 percent
D) International reserves decrease by 2 percent and foreign inflation falls by 2 percent

Question 15

In the Bretton Woods system, if the U.S. increases its money supply, foreign central banks will have to intervene by ______ dollars and ______ foreign currencies to maintain a fixed exchange rate.

A) selling; selling
B) selling: buying
C) buying; selling
D) buying; buying

Question 16

The MABP emphasizes money demand and money supply as determinants of:

A) The balance of payments under the fixed exchange rate.
B) The balance of payments under the floating exchange rate.
C) Exchange rate movements
D) Capital flows

Question 17

Starting from a position where a country's money demand equals the money supply and its balance of payments is in equilibrium. According to the monetary approach, an expansionary monetary policy will lead to an) ______ of the home currency under flexible exchange rate regime; whereas it will cause trade _______ under fixed exchange rate.

A) depreciation; deficit
B) depreciation; surplus
C) appreciation; deficit
D) appreciation; surplus

Question 18

Which of the following statements are true? I. Under MAER, central bank intervention is used to restore equilibrium.
II) Under MAER, monetary policy in one country does not affect other countries.

A) I only
B) II only
C) I and II
D) Neither I nor II

Question 19

A central bank sale of _____ to purchase ______ in the foreign exchange market results in a rise in its international reserves and the money base.

A) foreign assets; domestic currency
B) foreign assets; foreign currency
C) domestic currency; foreign assets
D) domestic currency; domestic currency

Question 20

Suppose that the Fed increases the U.S. money supply and the Bretton Woods system of fixed exchange rates is still in place. Then to maintain the fixed exchange rate, foreign central banks intervene by:

A) Raising the interest rate on dollars.
B) Buying dollars and selling its currency.
C) Raising the interest rate on its currency.
D) Selling dollars and buying its currency.

Question 21

The MAER emphasizes money demand and money supply as determinants of exchange rate movements.

Question 22

According to the monetary approach of the balance of payments MABP), if the foreign inflation rate decreases 50%, the U.S. foreign reserves will

A) increase because foreign central bank buys U.S. dollars and sells its currency.
B) increase because foreign central bank buys its currency and sells U.S. dollars.
C) decrease because foreign central bank buys U.S. dollars and sells its currency.
D) decrease because foreign central bank buys its currency and sells U.S. dollars.

Question 23

Assume floating exchange rates. Suppose there are a 5% growth in U.S output and a 5% increase in foreign inflation. Then, which of the following will offset these changes?

A) 10% increase in money supply.
B) 10% decrease in money supply.
C) 10% increase in the exchange rate.
D) The two changes offset each other.

Question 24

When China's central bank authorities acquire U.S. dollars faster than the Federal Reserve Bank acquires Chinese yuan, then the percentage change of U.S. international reserves ):

A) decreases
B) increases
C) stays the same
D) increases first and then decreases.

Question 25

According to the monetary approach of the balance of payments MABP), an increase in U.S. money supply growth will cause the U.S. foreign reserves ):

A) to fall, as foreign central bank selling its currency and buying U.S. dollars.
B) to fall, as foreign central bank selling U.S. dollars and buying its currency.
C) to rise, as foreign central bank selling its currency and buying U.S. dollars.
D) to rise, as foreign central bank selling U.S. dollars and buying its currency.

Question 26

Inflation from one country can be transmitted to another if a floating exchange rate is being used.

Question 27

The monetary approach states that, under a fixed exchange rate system, an excess demand for money leads to a trade deficit.

Question 28

Assume floating exchange rates. Suppose there are a 5% growth in U.S output and the Fed increases in U.S. money supply by 5%. Then, which of the following will offset these changes?

A) 10% increase in exchange rate.
B) 10% decrease in exchange rate.
C) 10% increase in the foreign inflation.
D) The two changes offset each other.

Question 29

The official holdings of gold and foreign exchange, special drawing rights SDRs), and changes in reserves at the International Monetary Fund are known as:

A) Official settlements balance
B) Central bank holdings
C) Current account balance
D) Capital account balance

Question 30

Action by a central bank to offset the effect of a foreign exchange intervention, on the domestic money supply, by using the open-market operations is known as:

A) Monetary protectionism
B) Sterilized intervention
C) Currency creation
D) Injecting money supply

Question 31

The monetary approach in the case of a managed floating exchange rate:

A) Is like that of currency boards.
B) Introduces variables to represent changes in fiscal policy.
C) Is a combination of MABP and MAER.
D) Is not possible to model.

Question 32

Suppose the Bank of England is using a managed floating exchange regime. In order to keep money supply constant the Bank of England exchanges domestic bonds for foreign bonds to slow any appreciation of the pound while keeping the British money supply unchanged. This process is known as:

A) Sterilized intervention
B) The monetary approach
C) Exchange rate intervention
D) Balancing official settlements.

Question 33

The offsetting of international reserve flows by central banks that wish to follow an independent monetary policy is known as:

A) Printing money
B) Balancing the official settlements
C) The monetary approach
D) Sterilization

Question 34

The MABP implies that the change in international reserves equals to the foreign inflation rate plus the growth rate of domestic output minus the change in domestic money creation.

Question 35

According to the monetary approach, when a monetary disequilibrium exists, either ____________ or _____________ has to adjust depending on the type of exchange rate system.

A) the balance of payments; domestic production
B) the balance of payments; exchange rate value
C) domestic production; exchange rate value
D) domestic production; foreign inflation rate

Question 36

Under MABP, the full effect of the monetary policy is felt on the exchange rate.

Question 37

When the central bank increases the money supply,

A) the money supply curve shifts to the left and interest rate rises.
B) the money supply curve shifts to the left and interest rate falls.
C) the money supply curve shifts to the right and interest rate rises.
D) the money supply curve shifts to the right and interest rate falls.

Question 38

According to Hume's Specie Flow Mechanism, during the Gold Standard, if the domestic inflation rises sharply, the domestic country will experience ___________ and the foreign trading partner will experience __________.

A) trade deficit; higher prices.
B) trade deficit; lower prices.
C) trade surplus; higher prices.
D) trade surplus; lower prices.

Question 39

To derive the monetary approach, we need money demand equals to money supply and:

A) leakages equal injections.
B) absolute purchasing power parity to hold.
C) covered interest parity to hold.
D) All of the above are correct.

Question 40

Assume there is a reduction in U.S. output. Then under MAER there will be an):

A) Increase in domestic money supply
B) Decrease in domestic money supply
C) Increase in the exchange rate dollar/foreign currency)
D) Decrease in the exchange rate dollar/foreign currency)

Question 41

Base money equals to:

A) domestic credit plus domestic bonds
B) domestic credit plus international reserves
C) domestic credit minus international reserves
D) domestic bonds plus foreign bonds

Question 42

Under the flexible exchange rate regime, which of the following variables in the monetary approach becomes zero and is dropped out of the equation?

A) Percentage change in domestic credit
B) Percentage change in spot exchange rate
C) Percentage change in foreign reserves
D) Percentage change in money demand

Question 43

Assume that China and the U.S. are in a managed floating exchange rate agreement. Suppose that the Fed decreases the money supply by 50%. China's central bank lets the exchange rate partly adjust and also intervenes in foreign exchange market. What would happen to the foreign reserve position for the U.S. and the exchange rate $/yuan?

A) Foreign reserves decrease and exchange rate decreases.
B) Foreign reserves increases and exchange rate increases.
C) Foreign reserves decrease and exchange rate increases.
D) Foreign reserves increase and exchange rate decreases.

Question 44

"According to the monetary approach, a balance-of-payments disequilibrium is the result of an imbalance in a country's money supply and money demand."

Question 45

In a perfectly floating exchange rate regime, according to the monetary approach to the exchange rate MAER), what would be the effect of a decrease in U.S. output growth by 3% on the dollar price of a Swiss franc $/SFr)?

A) Swiss franc would depreciate against the dollar.
B) Swiss franc would appreciate against the dollar.
C) The exchange rate remains unaffected.
D) The dollar would appreciate against the Swiss Franc.

Question 46

According to the monetary approach to the balance of payments, which of the following economic events would help a country to resolve its balance of trade deficit?

A) An increase in money supply
B) A decrease in money supply
C) A fall of foreign price level
D) A fall of domestic income

Question 47

Which of the following equations correctly represents the monetary approach to the balance of payments MABP)?

A) $\dot { \mathrm { R } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } - \dot { \mathrm { D } }$
B) $- \dot { \mathrm { R } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } - \dot { \mathrm { D } }$
C) $\dot { \mathrm { R } } - \dot { \mathrm { S } } _ { \mathrm { S } / \mathrm { FC } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } + \dot { \mathrm { D } }$
D) $\dot { \mathrm { R } } - \dot { \mathrm { S } } _ { \mathrm { S } / \mathrm { FC } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } - \dot { \mathrm { D } }$

Question 48

"Under the monetary approach to exchange rate, a rise in domestic income will cause a depreciation of domestic currency."

Question 49

Starting from a position where a nation's money demand equals the money supply and its balance of payments is in equilibrium. According to the monetary approach to the balance of payments, when the nation's central bank increases money supply, the balance of trade moves into ________ position and net official holding of foreign reserves ________.

A) surplus; increases
B) surplus; decreases
C) deficit; increases
D) deficit; decreases

Question 50

Which of the following equations correctly represents the monetary approach to the exchange rate MAER)?

A) $\dot { \mathrm { S } } _ { \$ / \mathrm { FC } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } - \dot { \mathrm { D } }$
B) $- \dot { \mathrm { S } } _ { \mathrm { S } / \mathrm { FC } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } - \dot { \mathrm { D } }$
C) $- \dot { \mathrm { S } } _ { \$ / \mathrm { FC } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } + \dot { \mathrm { D } }$
D) $\dot { \mathrm { R } } - \dot { \mathrm { S } } _ { \mathrm { S } / \mathrm { FC } } = \dot { \mathrm { P } } _ { \mathrm { FC } } + \dot { \mathrm { Y } } _ { \mathrm { US } } - \dot { \mathrm { D } }$

Question 51

"Under the fixed exchange rate, inflation from one country can be transmitted to the other country."

Question 52

"Under the monetary approach to exchange rate, a rise in domestic money supply will cause a depreciation of domestic currency."

Question 53

"Under the specie flow mechanism, a trade-surplus nation would realize gold inflows, an increase in its money supply, and a rise of domestic inflation."