Deck 21: Exchange Rate Regimes

Question 1

Suppose a country that has been pegging its currency is faced with a situation where financial market participants now expect some future devaluation.In such a situation,we would generally expect which of the following to occur?

A)a reduction in the domestic interest rate.
B)an announcement by the central bank that a large devaluation will occur in the near future.
C)reduction in demand for the country's currency.
D)all of the above
E)none of the above

Answer 1

A

Question 2

Which of the following is an argument of opponents of devaluations?

A)devaluations cause relatively slow adjustments.
B)participants in foreign exchange markets have a short memory: if the expected devaluation doesn't occur within a short time-period,they will stop expecting it.
C)a devaluation causes a nation with fixed exchange rates to lose credibility in the medium run,driving its interest rate higher.
D)all of the above
E)none of the above

Answer 2

C

Question 3

Under the Gold Standard,

A)exchange rates could float.
B)real interest rates were fixed.
C)real exchange rates were fixed.
D)nominal interest rates were fixed.
E)none of the above

Answer 3

E

Question 4

Suppose country A pegs its nominal exchange rate to country B and that country A has a higher inflation rate than country B.In this situation,country A will experience

A)a real appreciation.
B)a worsening trade position.
C)an increase in the real exchange rate.
D)all of the above
E)none of the above

Question 5

If the exchange rate between two countries is expected to remain fixed at its current rate,then

A)output growth rates must be equal in the two countries.
B)price levels must be equal in the two countries.
C)inflation rates must be equal in the two countries.
D)nominal interest rates must be equal in the two countries.
E)none of the above

Question 6

For this question,assume that interest parity holds,the future expected exchange rate is constant,the current nominal exchange rate is 1.2,the one-year foreign interest rate is 6% and the one-year domestic interest rate is 3%.Given this information,one can conclude that

A)financial market participants expect that the exchange rate (E)will increase by 3% over the coming year.
B)financial market participants expect that the exchange rate (E)will decrease by 3% over the coming year.
C)financial market participants expect that the domestic currency to depreciate by 3% over the coming year.
D)financial market participants expect that the exchange rate (E)will increase by 20% over the coming year.

Question 7

In a fixed exchange rate regime,which of the following policies could be implemented to reduce a trade deficit and leave aggregate demand constant?

A)devalue the currency
B)increase government spending
C)decrease government spending
D)decrease government spending and devalue the currency
E)increase government spending and revalue the currency

Question 8

Suppose a country is perceived to have an overvalued real exchange rate does not devalue.Which of the following would we expect to occur over time?

A)a reduction in its price level
B)a real depreciation of its currency
C)a reduction in its trade surplus
D)all of the above
E)none of the above

Question 9

Part of the reason for the Mexican peso crisis of 1994 was Mexico's decision to

A)allow the peso to depreciate too rapidly.
B)allow the peso to appreciate too rapidly.
C)maintain relatively low nominal interest rates in the face of relatively high inflation.
D)maintain a roughly fixed nominal exchange rate in the face of relatively high inflation.
E)run a very small budget deficit in the face of relatively high inflation.

Question 10

In chapter 21,the expected future nominal exchange rate in the long run say,Eet+n,is assumed to be the nominal exchange rate at which

A)the current account is in balance.
B)the future rate of appreciation or depreciation is constant.
C)domestic and foreign price levels are equal.
D)one unit of foreign currency exchanges for one unit of domestic currency.
E)none of the above

Question 11

An increase in the domestic one-year interest rate expected to occur in,say,two years will,all else fixed,have which of the following effects in a flexible exchange rate regime?

A)the real exchange rate will increase with no change in the nominal exchange rate.
B)the nominal exchange rate will increase with no change in the real exchange rate.
C)both the real and nominal exchange rate will increase.
D)no change in either the nominal or real exchange rate.

Question 12

A country which does not devalue when financial markets expect it to will probably suffer

A)a real appreciation of its currency.
B)higher interest rates.
C)a default on its national debt.
D)all of the above
E)none of the above

Question 13

In a fixed exchange rate regime,a reduction in the price level will cause which of the following?

A)a real appreciation and a leftward shift in the aggregate demand curve
B)a real appreciation and no shift in the aggregate demand curve
C)a real depreciation and a rightward shift in the aggregate demand curve
D)a real depreciation and no shift in the aggregate demand curve
E)no change in the real exchange rate,and no change in aggregate demand

Question 14

Refer to the information above.The price of U.S.goods measured in pounds is

A).8.
B)1.0.
C)1.6.
D)2.
E)none of the above

Question 15

Changes in which of the following variables will cause the current nominal exchange rate to change?

A)the future expected long-run nominal exchange rate,Eet+n
B)future expected domestic nominal interest rates
C)future expected foreign nominal interest rates
D)all of the above

Question 16

An increase in the foreign one-year interest rate expected to occur in,say,two years will,all else fixed,have which of the following effects in a flexible exchange rate regime?

A)the real exchange rate will decrease with no change in the nominal exchange rate.
B)the nominal exchange rate will decrease with no change in the real exchange rate.
C)both the real and nominal exchange rate will decrease.
D)no change in either the nominal or real exchange rate.
E)both the real and nominal exchange rate will increase.

Question 17

Suppose foreign exchange markets anticipate a devaluation for country A.Further assume that policy makers in country A will continue to fix its nominal exchange rate.In order to peg the currency at its original level,which of the following must occur?

A)increase the domestic interest rate
B)increase the domestic price level
C)convince trading partners to raise their interest rates
D)all of the above
E)none of the above

Question 18

A revaluation causes which of the following to occur in the short run in the AS / AD model?

A)a reduction in net exports
B)a reduction in the price level
C)a reduction in output
D)all of the above
E)none of the above

Question 19

After Britain returned to the Gold Standard in the 1920s,the British pound was

A)undervalued,contributing to a long period of inflation.
B)undervalued,contributing to a long period of recession.
C)overvalued,contributing to a long period of inflation.
D)overvalued,contributing to a long period of recession.
E)value about right,leading to a long period healthy growth with almost no inflation.

Question 20

A devaluation causes which of the following to occur in the medium run?

A)an increase in net exports
B)an increase in the price level
C)an increase in output
D)all of the above
E)none of the above

Question 21

Which of the following,according to the Maastricht treaty,was a condition for participating in the common currency area?

A)a relatively small budget deficit-to-GDP ratio
B)at least half the population of the country must speak German,French and English
C)a promise that any future devaluations will be announced in advance
D)the replacement of the country's prime minister with an appointee of the new "United States of Europe"
E)a relatively small amount of foreign aid to countries outside the area

Question 22

For this question,assume that policy makers are pursuing a fixed exchange rate regime and that output is initially less than the natural level of output.The economy will tend to move toward the natural level of output when which of the following occur?

A)an increase in the price level
B)a devaluation of the currency
C)an increase in the domestic interest rate
D)a reduction in the foreign price level
E)none of the above

Question 23

Assume that policy makers are pursuing a fixed exchange rate regime.Assume that the economy is initially operating at the natural level (i.e.,Y = Yn).Suppose an increase in wealth causes households to increase consumption.This wealth-induced increase in consumption will cause which of the following to occur?

A)the real exchange rate will be permanently higher in the medium run.
B)the real exchange rate will be permanently lower in the medium run.
C)the effects of this devaluation on the real exchange rate will be ambiguous in the medium run.
D)the real exchange rate will be unchanged in the medium run.

Question 24

After continuing crises in 1993,the EMS countries

A)agreed to entirely abandon the system.
B)stood firm,refusing to adjust central parities.
C)narrowed the band of allowable fluctuations around central parities.
D)removed France from its leading role in the system.
E)widened the band of allowable fluctuations around central parities.

Question 25

Policy makers can select from a number of different exchange rate regimes and exchange rate policies.Which of the following policies would most likely represent a hard peg?

A)a revaluation
B)a devaluation
C)a flexible exchange rate regime
D)a dollarization

Question 26

Which of the following is an advantage of a common currency in Europe?

A)each country could conduct its own,independent monetary policy.
B)exchange rate uncertainty within the common currency area would be eliminated.
C)each country could conduct its own,independent fiscal policy.
D)all of the above
E)none of the above

Question 27

When policy makers decide to devalue the currency,such an action generally represents

A)a decision to let the currency float.
B)an increase in the pegged value of the domestic currency.
C)a reduction in the foreign price level.
D)a reduction in the domestic price level.
E)none of the above

Question 28

For this question,assume that exchange rates flexible and that the exchange rate expected to occur in one year is NOT constant.Suppose that individuals now expect that the domestic central bank will pursue expansionary monetary policy in one year.This expected future monetary expansion will cause which of the following to occur?

A)the current nominal exchange rate will decrease.
B)the current nominal exchange rate will increase.
C)the current nominal exchange rate will not change.
D)the effects on the current nominal exchange rate are ambiguous.

Question 29

Policy makers can select from a number of different exchange rate regimes.One of those options is a "hard peg." Which of the following best represents a hard peg?

A)a revaluation
B)a currency board
C)a flexible exchange rate regime
D)the EMS
E)none of the above

Question 30

An adjustment of central parities in the EMS is called a

A)realignment.
B)nominal appreciation or nominal depreciation.
C)real appreciation or real depreciation.
D)re-coupling.
E)re-paritization.

Question 31

Assume that policy makers are pursuing a fixed exchange rate regime.Assume that the economy is initially operating at the natural level (i.e.,Y = Yn).Suppose fiscal policy makers increase taxes.This fiscal contraction will cause which of the following?

A)the real exchange rate will be permanently higher in the medium run.
B)the real exchange rate will be permanently lower in the medium run.
C)the effects of this devaluation on the real exchange rate will be ambiguous in the medium run.
D)the real exchange rate will be unchanged in the medium run.
E)none of the above

Question 32

For this question,assume that policy makers are pursuing a fixed exchange rate regime and that output is initially greater than the natural level of output.The economy will tend to move toward the natural level of output when which of the following occur?

A)an increase in the price level
B)a devaluation of the currency
C)a reduction in the domestic interest rate
D)an increase in the foreign price level
E)none of the above

Question 33

When policy makers decide to revalue the currency,such an action generally represents

A)an increase in the pegged value of the domestic currency.
B)a decision to let the currency float.
C)a reduction in the foreign price level.
D)an increase in the domestic price level.
E)none of the above

Question 34

A number of situations can arise that will cause individuals to believe that policy makers might change the pegged value of a fixed exchange rate.Suppose financial market participants expect a revaluation in the future.The interest parity condition will be maintained if which of the following policy actions are taken in the current period?

A)a reduction in the pegged value of the domestic currency
B)an increase in i
C)a reduction in i
D)an increase in government spending

Question 35

Suppose the country that pegs its currency has an overvalued real exchange rate and that output is currently above the natural level of output.Which of the following will occur as the economy adjusts to this situation?

A)P will decrease over time until Y = Yn.
B)a reduction in the pegged value of the domestic currency will cause a leftward shift of the AD curve.
C)net exports will increase as the economy adjusts to this situation.
D)domestic goods will become less competitive as the economy adjusts by itself.
E)none of the above

Question 36

During the EMS crisis in 1992,

A)all the EMS countries abandoned the system.
B)Germany abandoned the system.
C)England and Italy abandoned the system.
D)France was put in charge of the system.
E)all the EMS countries stood firm,and refused to change central parities.

Question 37

Assume that policy makers are pursuing a fixed exchange rate regime and that the economy is initially operating at the natural level of output.Which of the following will occur as a result of a revaluation?

A)the real exchange rate will be permanently higher in the medium run.
B)the real exchange rate will be permanently lower in the medium run.
C)the effects of this revaluation on the real exchange rate will be ambiguous in the medium run.
D)the real exchange rate will be unchanged in medium run.
E)the nominal exchange will initially fall in the short run and then increase in the medium run.

Question 38

European currencies taken out of circulation and replaced with the Euro in

A)1992.
B)1997.
C)1999.
D)2004.
E)none of the above

Question 39

The new European Central Bank is located in which country?

A)England
B)Italy
C)France
D)Spain
E)Germany

Question 40

Assume that policy makers are pursuing a fixed exchange rate regime and that the economy is initially operating at the natural level.Which of the following will occur as a result of a evaluation?

A)the real exchange rate will be permanently higher in the medium run.
B)the real exchange rate will be permanently lower in the medium run.
C)the effects of this devaluation on the real exchange rate will be ambiguous in the medium run.
D)the nominal exchange rate will initially increase in the short run and then decrease in the medium run.
E)none of the above

Question 41

Suppose output is above the natural level of output.In a fixed exchange rate regime,explain the two ways the economy can return to the natural level of output.

Question 42

When we no longer assume that the exchange rate expected to occur in one year is constant,explain what variables affect the current exchange rate in a flexible exchange rate regime.Include in your answer an explanation of how changes in these variables affect the current exchange rate.

Question 43

Suppose the economy is operating below the natural level of output.Discuss the arguments for and against using a devaluation in such a situation.

Question 44

Suppose a reduction in the domestic one-year interest rate expected to occur in two years .All else fixed,will the reduction in interest rate have which of the following effects in a flexible exchange rate regime?

A)the real exchange rate will decrease with no change in the nominal exchange rate.
B)the nominal exchange rate will decrease with no change in the real exchange rate.
C)both the real and nominal exchange rate will decrease.
D)no change in either the nominal or real exchange rate.

Question 45

Suppose foreign exchange markets anticipate a revaluation for country A.Further assume that policy makers in country A will continue to fix its nominal exchange rate.In order to peg the currency at its original level,which of the following must occur?

A)increase the domestic interest rate.
B)increase the domestic price level.
C)convince trading partners to raise their interest rates.
D)all of the above
E)none of the above

Question 46

Explain why exchange rates are more volatile than is suggested by the relatively simply interest parity condition presented earlier in the course.

Question 47

Suppose a country that has been pegging its currency is faced with a situation where financial market participants now expect some future revaluation.In such a situation,we would generally expect which of the following to occur?

A)an increase in the domestic interest rate
B)an announcement by the central bank that a large revaluation will occur in the near future
C)an increase in demand for the country's currency
D)all of the above
E)none of the above

Question 48

For this question,assume that exchange rates are flexible and that the exchange rate expected to occur in one year is NOT constant.Suppose that individuals now expect that the foreign central bank will pursue expansionary monetary policy in one year.This expected future monetary expansion by the foreign central bank will cause which of the following to occur?

A)the current nominal exchange rate will decrease.
B)the current nominal exchange rate will increase.
C)the current nominal exchange rate will not change.
D)the effects on the current nominal exchange rate are ambiguous.

Question 49

In a fixed exchange rate regime,an increase in the price level will cause which of the following?

A)a real appreciation and a leftward shift in the aggregate demand curve
B)a real appreciation and no shift in the aggregate demand curve
C)a real depreciation and a rightward shift in the aggregate demand curve
D)a real depreciation and no shift in the aggregate demand curve
E)no change in the real exchange rate,and no change in aggregate demand

Question 50

A country which does not revalue when financial markets expect it to will probably suffer

A)a real depreciation of its currency
B)lower interest rates
C)a default on its national debt
D)all of the above
E)none of the above

Question 51

Explain what factors cause shifts of the aggregate demand curve in the open economy model.

Question 52

Assume that policy makers are pursuing a fixed exchange rate regime.Assume that the economy is initially operating at the natural level (i.e.,Y = Yn).Suppose a reduction in wealth causes households to reduce consumption.This wealth-induced decrease in consumption will cause which of the following to occur?

A)the real exchange rate will be permanently higher in the medium run.
B)the real exchange rate will be permanently lower in the medium run.
C)the effects of this devaluation on the real exchange rate will be ambiguous in the medium run.
D)the real exchange rate will be unchanged in the medium run.

Question 53

Euro coins and bank notes were introduced in January

A)2002.
B)2001.
C)2000.
D)1999.

Question 54

Assume a country is in a fixed exchange rate regime.Explain what factors might cause individuals to expect that a country will revalue its currency.

Question 55

Assume that policy makers are pursuing a fixed exchange rate regime.Assume that the economy is initially operating at the natural level (i.e.,Y = Yn).Suppose fiscal policy makers increase government spending.This fiscal contraction will cause which of the following?

A)the real exchange rate will be permanently higher in the medium run.
B)the real exchange rate will be permanently lower in the medium run.
C)the effects of this devaluation on the real exchange rate will be ambiguous in the medium run.
D)the real exchange rate will be unchanged in the medium run.
E)none of the above

Question 56

Suppose country A pegs its nominal exchange rate to country B and that country A has a lower inflation rate than country B.In this situation,country A will experience

A)a real depreciation.
B)a better trade position.
C)a reduction in the real exchange rate.
D)all of the above
E)none of the above

Question 57

First,briefly explain why the AD curve is downward sloping in a closed economy.Second,briefly explain why the AD curve is downward sloping in an open economy under fixed exchange rates.And finally,briefly compare the size of the slopes of the two AD curves.

Question 58

In a fixed exchange rate regime,which of the following policies could lead to a greater trade deficit and leave aggregate demand constant?

A)devalue the currency.
B)increase government spending.
C)decrease government spending.
D)decrease government spending and devalue the currency.
E)increase government spending and revalue the currency.

Question 59

Assume a country is in a fixed exchange rate regime.Now suppose that individuals expect that policy makers will revalue its currency.Explain the various actions that policy makers can choose in response to this expected revaluation.

Question 60

Suppose the economy is initially operating above the natural level of output.In a fixed exchange rate regime,explain how the economy will adjust to this situation.

Question 61

Explain exchange rate crisis.

Question 62

Explain each of the following and why each might be used: hard pegs,currency boards,and dollarizations.

Question 63

Assume a country is in a fixed exchange rate regime.Explain what factors might cause individuals to expect that a country will devalue its currency.

Question 64

What is an "optimal currency area"? Also,discuss the conditions that must be satisfied for an optimal currency area to exist.

Question 65

According to Mundell,countries to constitute an optimal currency area need to satisfy one of the two conditions.Explain these conditions.

Question 66

Does Europe constitute an optimal common currency area? Why?

Question 67

Explain the cases for and against flexible and fixed exchange rate regimes.

Question 68

Assume a country is in a fixed exchange rate regime.Now suppose that individuals expect that policy makers will devalue its currency.Explain the various actions that policy makers can choose in response to this expected devaluation.