Deck 20: Output,the Interest Rate,and the Exchange Rate

Question 1

An increase in the real exchange rate will cause

A)an increase in net exports.
B)an increase in the quantity of imports.
C)an increase in output.
D)a decrease in government spending.
E)all of the above

Answer 1

B

Question 2

Assume that the price levels in two countries are constant.In this situation,we know that

A)neither the real nor the nominal exchange rate can change.
B)the real exchange rate can change,while the nominal exchange rate is constant
C)the nominal exchange rate can change,while the real exchange rate is constant.
D)the real and nominal exchange rate must move together,changing by the same percentage.
E)the nominal exchange rate will fluctuate more widely than the real exchange rate.

Answer 2

D

Question 3

Assume that the interest parity condition holds.Also assume that the U.S.interest rate is 8% while the U.K.interest rate is 6%.Given this information,financial markets expect the pound to

A)depreciate by 14%.
B)depreciate by 2%.
C)appreciate by 2%.
D)appreciate by 6%.
E)appreciate by 14%.

Answer 3

C

Question 4

Assume that the interest parity condition holds and that both the expected exchange rate and foreign interest rate are constant.Given this information,a reduction in the domestic interest rate will cause

A)a reduction in the exchange rate expected in the future.
B)a reduction in the current exchange rate.
C)greater depreciation of the domestic currency expected in the future.
D)all of the above
E)none of the above

Question 5

In an open economy under flexible exchange rates,a reduction in the interest rate will cause a reduction in which of the following?

A)investment
B)the exchange rate,E
C)net exports
D)all of the above
E)none of the above

Question 6

A real appreciation will tend to cause

A)an increase in exports.
B)a reduction in imports.
C)an increase in net exports.
D)a reduction in demand for domestic goods.
E)none of the above

Question 7

Suppose a country switches from a fixed to a flexible exchange rate.Which of the following will occur as a result of this change?

A)monetary policy will become a less effective tool for changing output.
B)a given change in government spending will now have a greater effect on output.
C)both fiscal and monetary policy will become more effective in changing GDP.
D)both fiscal and monetary policy will become completely ineffective in changing GDP.
E)none of the above

Question 8

As the economy moves up and to the left along the IS curve,which of the following will occur when exchange rates are flexible?

A)investment spending decreases
B)consumption decreases
C)the domestic currency appreciates
D)all of the above
E)none of the above

Question 9

The interest parity condition indicates that the domestic interest rate must be equal to

A)the foreign interest rate.
B)the expected rate of depreciation of the domestic currency.
C)the expected rate of appreciation of the domestic currency.
D)the foreign interest rate minus the expected rate of appreciation of the foreign currency.
E)none of the above

Question 10

In an open economy under flexible exchange rates,a reduction in consumer confidence that causes a reduction in consumption will cause which of the following?

A)an appreciation of the domestic currency
B)a reduction in the exchange rate,E
C)a reduction in net exports
D)all of the above
E)none of the above

Question 11

In an open economy,we know that individuals must choose between which of the following?

A)domestic bonds and foreign currency
B)foreign goods and domestic currency
C)domestic and foreign bonds
D)domestic goods and foreign currency
E)none of the above

Question 12

Under a "crawling peg" system,a country's exchange rate

A)is fixed except for small,surprise changes.
B)changes at a predetermined rate against the dollar or some other major currency.
C)can fluctuate within a narrow band.
D)can change,but the changes are kept secret from the public.
E)is determined by the central bank of another country.

Question 13

For this question,assume that the economy is operating in a fixed exchange rate regime and that perfect capital mobility exists.Given this information,which of the following will occur?

A)the domestic and foreign interest rates must be equal.
B)the central bank cannot use monetary policy to affect domestic output.
C)an expansionary fiscal policy will require that the central bank increase the money supply.
D)all of the above
E)none of the above

Question 14

In order for an individual to be indifferent between holding foreign or domestic bonds,

A)the Marshall-Lerner condition must hold.
B)the foreign and domestic interest rates must be equal.
C)the expected rate of depreciation of the domestic currency is zero.
D)the interest parity condition must hold.

Question 15

In 2005,China increased the price of its currency while continuing to pursue a fixed exchange rate.This change in policy is called

A)an appreciation.
B)a depreciation.
C)a peg.
D)a devaluation.
E)a revaluation.

Question 16

Suppose a country with a fixed exchange rate decides to reduce the price of its currency.This change in policy is called

A)an appreciation.
B)a depreciation.
C)a peg.
D)a devaluation.
E)a revaluation.

Question 17

In an open economy under flexible exchange rates and represented by the IS-LM-IP model,a reduction in government spending will cause a reduction in which of the following?

A)net exports
B)the exchange rate,E
C)exports
D)all of the above
E)none of the above

Question 18

Assume that the interest parity holds and that the dollar is expected to depreciate against the pound.Given this information,we know that

A)U.S.and U.K.interest rates are equal.
B)the U.S.interest rate exceeds the U.K.interest rate.
C)the U.K.interest rate exceeds the U.S.interest rate.
D)individuals will prefer to hold U.S.bonds because the U.S.interest rate exceeds the U.K.interest rate.
E)none of the above

Question 19

In an open economy under flexible exchange rates,expansionary monetary policy that results in an increase in the money supply will always cause

A)an increase in output.
B)an increase in exports.
C)a reduction in the exchange rate,E.
D)all of the above
E)only A and C

Question 20

The exchange rate policy of the United States is

A)the EMS.
B)a crawling peg.
C)a float.
D)a fixed rate within a band.
E)none of the above

Question 21

Under a fixed exchange rate regime,the central bank must act to keep

A)P = P*.
B)the real exchange rate fixed.
C)i = i*.
D)E = 1.
E)none of the above

Question 22

The European Monetary System represented a

A)exchange rate regime with 'bands.'
B)crawling peg.
C)a flexible exchange rate regime.
D)none of the above

Question 23

Under a fixed exchange rate regime,suppose there is a reduction in housing wealth that causes a reduction in consumption.This wealth-induced reduction in consumption will cause

A)a reduction in investment.
B)an increase in net exports.
C)a reduction in imports.
D)all of the above
E)none of the above

Question 24

For this question,assume that there is a simultaneous tax increase and monetary expansion.In a flexible exchange rate regime,we know with certainty that

A)the exchange rate and output would both increase.
B)the exchange rate would increase and output would decrease.
C)the exchange rate would decrease.
D)the exchange rate would decrease and output would increase.
E)none of the above

Question 25

Assume that the current exchange rate between U.K.pound and the U.S.dollar is 2 (E = 2.0).If interest parity holds,and the U.S.interest rate is 6% while the U.K.interest rate is 8%,the expected exchange rate in one year is

A)1.98.
B)1.99.
C)2.01.
D)2.02.
E)2.04.

Question 26

For this question,assume that policy makers are pursuing a fixed exchange rate regime.Now suppose a budget is passed that calls for a reduction in government spending.This reduction in government spending will cause which of the following to occur?

A)a reduction in i and an increase in E
B)a reduction in investment
C)no change in output
D)no change in net exports
E)an increase in imports

Question 27

For this question,assume that policy makers are pursuing a fixed exchange rate regime.Now suppose that an increase in stock market wealth causes an increase in consumption.Which of the following will tend to occur in a fixed exchange rate regime?

A)an increase in Y
B)an increase in the money supply
C)no change in the domestic interest rate
D)all of the above

Question 28

In the early 1990s,which nation took the lead in driving up European interest rates?

A)Spain
B)France
C)Germany
D)England
E)none of the above

Question 29

Under a fixed exchange rate regime,expansionary fiscal policy will tend to cause which of the following?

A)an increase in imports
B)an increase in net exports
C)a reduction in investment
D)all of the above

Question 30

In the early 1990s,European unemployment rose largely because of

A)reductions in stock prices.
B)undervalued currencies.
C)overvalued currencies.
D)high inflation
E)none of the above

Question 31

Assume policy makers in a fixed exchange rate regime decide to peg the exchange rate at a higher level.This is called

A)a devaluation.
B)a revaluation.
C)a depreciation.
D)an appreciation.

Question 32

For this question,assume that there is a simultaneous increase in government spending and monetary contraction.In a flexible exchange rate regime,we know with certainty that such a policy mix will cause which of the following?

A)an increase in the domestic interest rate
B)an increase in the exchange rate
C)a reduction in net exports
D)all of the above
E)only A and C

Question 33

Suppose a country is pursuing a fixed exchange rate regime with imperfect capital mobility.The ability of that country to move its domestic interest rate while maintaining its exchange rate will depend on

A)the degree of development of its financial markets.
B)the degree of capital controls.
C)the amount of foreign exchange it holds.
D)all of the above
E)both A and B

Question 34

In practice,under the EMS,a member country

A)could never change its interest rate.
B)could change its interest rate only if other countries changed theirs as well.
C)must apply to a special European Commission in order to change its interest rate.
D)had complete freedom in choosing the interest rate it wanted.
E)had complete freedom in choosing its interest rate only if it is a very small country.

Question 35

In a flexible exchange rate regime,an increase in the foreign interest rate (i*)will cause

A)the IP curve to shift to the left / up.
B)the IP curve to shift to the right / down.
C)a movement along the IP curve.
D)neither a shift nor movement along the IP curve.

Question 36

A common argument for fixed exchange rates is that they

A)give central banks greater freedom in adjusting their economy's level of output.
B)forever free the central bank from have to adjust the exchange rate to fundamental changes in the economy.
C)make trade more costly,and thus encourage domestic citizens to buy domestically produced output.
D)all of the above
E)none of the above

Question 37

Suppose policy makers are pursuing a policy to fix the exchange rate.In such a system with perfect capital mobility,an open market purchase of domestic bonds by the domestic central bank will eventually result in

A)a permanent increase in the monetary base.
B)a permanent reduction in the monetary base.
C)a change in the composition of the monetary base.
D)a gradual reduction in the domestic interest rate.

Question 38

Suppose policy makers are pursuing a policy to fix the exchange rate.In such a system with perfect capital mobility,an open market sale of domestic bonds by the domestic central bank will eventually result in

A)a permanent increase in the monetary base.
B)a permanent reduction in the monetary base.
C)a gradual reduction in the domestic interest rate.
D)a change in the composition of the monetary base.

Question 39

For this question,assume that policy makers are pursuing a fixed exchange rate regime.Now suppose that households decide to decrease consumption because of,for example,a reduction in consumer confidence.Given this information,we would expect which of the following to occur?

A)a reduction in the domestic interest rate
B)an increase in E
C)a reduction in E
D)a reduction in investment
E)none of the above

Question 40

Assume policy makers in a fixed exchange rate regime decide to peg the exchange rate at a lower level.This is called

A)a devaluation.
B)a revaluation.
C)a depreciation.
D)an appreciation.

Question 41

In an economy operating under flexible exchange rates,explain why the IS curve is downward sloping.

Question 42

For this question,assume that policy makers are pursuing a fixed exchange rate regime.Now suppose that households decide to increase consumption because of,for example,an increase in consumer confidence.Given this information,we would expect which of the following to occur?

A)an increase in the domestic interest rate
B)a reduction in E
C)an increase in E
D)an increase in investment
E)none of the above

Question 43

Suppose there are two countries that are identical in every way with the following exception.Country A is pursuing a fixed exchange rate regime and country B is pursuing a flexible exchange rate regime.Suppose taxes are increased in both countries rises by the same amount.Given this information,we know that

A)the change in output in A will be greater than in B.
B)the change in output in B will be greater than in A.
C)the change in output will be the same in both countries.
D)the relative output effects are ambiguous.

Question 44

In a flexible exchange rate regime,an increase in the expected future exchange rate will cause

A)the IP curve to shift to the left / up.
B)the IP curve to shift to the right / down.
C)a movement along the IP curve.
D)neither a shift nor movement along the IP curve.

Question 45

In a flexible exchange rate regime,a reduction in the foreign interest rate (i*)will cause

A)the IP curve to shift to the left / up
B)the IP curve to shift to the right / down
C)a movement along the IP curve
D)neither a shift nor movement along the IP curve

Question 46

Expansionary monetary policy in a flexible exchange rate regime will cause

A)a shift of the IP curve.
B)an appreciation of the domestic currency.
C)a reduction in E.
D)no change in E.

Question 47

Under a fixed exchange rate regime,contractionary fiscal policy will tend to cause which of the following?

A)a reduction in imports
B)a reduction in net exports
C)an increase in investment
D)all of the above

Question 48

Explain what the IP curve is and why it is upward sloping.

Question 49

Contractionary monetary policy in a flexible exchange rate regime will cause

A)a shift of the IP curve.
B)a depreciation of the domestic currency.
C)an increase in E.
D)no change in E.

Question 50

A reduction in the real exchange rate will cause

A)a reduction in net exports.
B)a reduction in the quantity of imports.
C)a reduction in output.
D)an increase in government spending.
E)all of the above

Question 51

As the economy moves up and to the right along the IS curve,which of the following will occur when exchange rates are flexible?

A)investment spending increases
B)consumption increases
C)the domestic currency depreciates
D)all of the above
E)none of the above

Question 52

Under a fixed exchange rate regime,suppose there is an increase in housing wealth that causes an increase in consumption.This wealth-induced increase in consumption will cause

A)an increase in investment.
B)a reduction in net exports.
C)an increase in imports.
D)all of the above
E)none of the above

Question 53

In a flexible exchange rate regime,a reduction in the expected future exchange rate will cause

A)the IP curve to shift to the left / up.
B)the IP curve to shift to the right / down.
C)a movement along the IP curve.
D)neither a shift nor movement along the IP curve.

Question 54

Assume that the interest parity condition holds.Also assume that the U.S.interest rate is 6% while the U.K.interest rate is 8%.Given this information,financial markets expect the pound to

A)depreciate by 14%.
B)depreciate by 2%.
C)appreciate by 2%.
D)appreciate by 6%.
E)appreciate by 14%.

Question 55

Suppose the domestic and foreign interest rates are both initially equal to 3%.Now suppose the domestic interest rate rises to 5%.Explain what effect this will have on the exchange rate.Also explain what must occur for the interest parity condition to be restored.

Question 56

For this question,assume that policy makers are pursuing a fixed exchange rate regime.Now suppose that a reduction in stock market wealth causes a decrease in consumption.Which of the following will tend to occur in a fixed exchange rate regime?

A)a reduction in Y
B)a reduction in the money supply
C)no change in the domestic interest rate
D)all of the above

Question 57

Assume that the interest parity holds and that the dollar is expected to appreciate against the pound.Given this information,we know that

A)U.S.and U.K.interest rates are equal.
B)the U.S.interest rate exceeds the U.K.interest rate.
C)the U.K.interest rate exceeds the U.S.interest rate.
D)individuals will prefer to hold U.S.bonds because the U.S.interest rate exceeds the U.K.interest rate.
E)none of the above

Question 58

Assume the interest parity condition holds and that initially i = i*.A reduction in the domestic interest rate will cause

A)an increase in the demand for the domestic currency.
B)a reduction in E.
C)an expected depreciation of the domestic currency.
D)all of the above

Question 59

A real depreciation will tend to cause

A)a reduction in exports.
B)an increase in imports.
C)a reduction in net exports.
D)an increase in demand for domestic goods.
E)none of the above

Question 60

Assume the interest parity condition holds and that initially i = i*.A reduction in the foreign interest rate (i*)will cause

A)an increase in the demand for the domestic currency.
B)an increase in E.
C)an expected depreciation of the domestic currency.
D)all of the above

Question 61

Assume that policy makers are pursuing a fixed exchange rate regime.Now suppose that the foreign interest rate falls.Discuss what policy makers must do to maintain the pegged exchange rate.Also discuss what effect this will have on domestic output and net exports.

Question 62

Assume the exchange rate is allowed to fluctuate freely.Using the IS-LM-IP model,graphically illustrate and explain what effect an increase in government spending will have on the domestic economy.In your graphs,clearly label all curves and equilibria.

Question 63

Assume the exchange rate is allowed to fluctuate freely.Using the IS-LM-IP model,graphically illustrate and explain what effect monetary expansion will have on the domestic economy.In your graphs,clearly label all curves and equilibria.

Question 64

To what extent can monetary policy be used to affect output in a fixed exchange rate regime? Explain.

Question 65

Assume the exchange rate is allowed to fluctuate freely.Using the IS-LM-IP model,graphically illustrate and explain what effect an increase in foreign output (Y*)will have on the domestic economy.In your graphs,clearly label all curves and equilibria.

Question 66

Assume the exchange rate is fixed.Using the IS-LM model,graphically illustrate and explain what effect an increase in consumer confidence will have on the domestic economy.In your graphs,clearly label all curves and equilibria.

Question 67

Assume that policy makers are pursuing a fixed exchange rate regime.Now suppose that the foreign interest rate increases.Discuss what policy makers must do to maintain the pegged exchange rate.Also discuss what effect this will have on domestic output and net exports.

Question 68

Assume the exchange rate is allowed to fluctuate freely.Using the IS-LM-IP model,graphically illustrate and explain what effect a reduction in government spending will have on the domestic economy.In your graphs,clearly label all curves and equilibria.

Question 69

Assume the exchange rate is allowed to fluctuate freely.Using the IS-LM-IP model,graphically illustrate and explain what effect a reduction in foreign output (Y*)will have on the domestic economy.In your graphs,clearly label all curves and equilibria.

Question 70

For a country pursuing a fixed exchange rate regime,what does the interest parity condition imply about domestic and foreign interest rates? Explain.

Question 71

Explain what effect each of the following events will have on the IS curve in a flexible exchange rate regime: (1)an increase in foreign output; (2)a reduction in the foreign interest rate; and (3)an increase in the domestic interest rate.

Question 72

Assume the exchange rate is allowed to fluctuate freely.Using the IS-LM-IP model,graphically illustrate and explain what effect monetary contraction will have on the domestic economy.In your graphs,clearly label all curves and equilibria.

Question 73

Suppose the domestic and foreign interest rates are both initially equal to 4%.Now suppose the foreign interest rate rises to 6%.Explain what effect this will have on the exchange rate.Also explain what must occur for the interest parity condition to be restored.

Question 74

Assume the exchange rate is fixed.Using the IS-LM model,graphically illustrate and explain what effect a reduction in consumer confidence will have on the domestic economy.In your graphs,clearly label all curves and equilibria.