Question 1

The "impossible trinity" refers to the idea that it is impossible for a country to simultaneously have:

Accepted Answer

A) low inflation, low unemployment, and a rapid rate of GDP growth. 
B) free capital flows, a fixed exchange rate, and an independent monetary policy. 
C) high interest rates, a budget deficit, and a trade deficit. 
D) an expansionary fiscal policy, a contractionary monetary policy, and a flexible exchange rate.

Question 2

If the exchange rate of currency A is fixed to a unit of currency B, then a potential problem for the central bank in charge of currency A is:

Accepted Answer

A) running out of currency A. 
B) running out of currency B. 
C) generating excessive revenue from seigniorage. 
D) ineffective fiscal policy.

Question 3

Exhibit: IS*-LM*  A small open economy with a fixed exchange rate e2 is initially at equilibrium A with  and equilibrium output Y1. If there is an increase in government spending to the new equilibrium will be at _____, holding everything else constant.

Accepted Answer

A) A 
B) B 
C) C 
D) D

Question 4

In a small open economy with a fixed exchange rate, if the country devalues its currency, then in the new short-run equilibrium the exchange rate _____, and the LM* curve shifts to the _____.

Accepted Answer

A) decreases; left 
B) increases; left 
C) decreases; right 
D) increases; right

Question 5

In the Mundell-Fleming model with flexible exchange rates, an increase in the price level results in a(n) _____ in the real exchange rate and a(n) _____ in net exports.

Accepted Answer

A) increase; increase 
B) increase; decrease 
C) decrease; decrease 
D) decrease; increase

Question 6

In the Mundell-Fleming model, if the economy is operating at or below the natural level in the short run, then in the long run the price level will fall, the exchange rate will _____, and net exports will _____ to restore the economy to its natural rate.

Accepted Answer

A) appreciate; increase 
B) appreciate; decrease 
C) depreciate; increase 
D) depreciate; decrease

Question 7

Country risk included in the risk premium in interest rates refers to the:

Accepted Answer

A) additional costs incurred when loans are made in currencies other than the domestic currency. 
B) possibility that loans in some countries may not be repaid because of political upheaval. 
C) expectation that the exchange rate may change in the future. 
D) potential change in the terms of trade between countries.

Question 8

Under a floating system, the exchange rate:

Accepted Answer

A) fluctuates in response to changing economic conditions. 
B) is maintained at a predetermined level by the central bank. 
C) is changed at regular intervals by the central bank. 
D) fluctuates in response to changes in the price of gold.

Question 9

If there is a fixed-exchange-rate system, then in the short run described by the Mundell-Fleming model:

Accepted Answer

A) the nominal exchange rate is fixed, but the real exchange rate is free to vary. 
B) the real exchange rate is fixed, but the nominal exchange rate is free to vary. 
C) both the nominal and real exchange rates are fixed. 
D) the nominal exchange rate is fixed, but whether the real exchange rate is fixed depends on whether the central bank follows a rule of constant growth of the money supply.

Question 10

The "impossible trinity" refers to the idea that a country can simultaneously pursue only two of the three following policies: free international-capital flows, monetary policy for domestic stabilization, and a fixed exchange rate. For each of the following combinations indicate what the economy gives up by selecting the combination and why the omitted policy cannot be achieved:
a.a fixed exchange rate and free international-capital flows
b.a monetary policy for domestic stabilization and a fixed exchange rate
c.a monetary policy for domestic stabilization and free international-capital flows

Accepted Answer

The answer of The "impossible trinity" refers to the idea...

Question 11

In a large open economy with a floating exchange rate, such as in the United States, in the short run a monetary contraction:

Accepted Answer

A) raises the interest rate and lowers investment and income, but does not affect the exchange rate. 
B) raises the exchange rate and lowers net exports and income, but does not affect the interest rate. 
C) initially raises the exchange rate, causing arbitrageurs to sell dollars and return the money supply to its initial level. 
D) raises the interest rate and lowers investment and income, but also raises the exchange rate and lowers net exports.

Question 12

A speculative attack on a currency occurs when:

Accepted Answer

A) a central bank switches from a floating to a fixed exchange rate. 
B) investors' perceptions change, making a fixed exchange rate untenable. 
C) a country accepts dollarization. 
D) a central bank adopts a currency board to back the domestic currency with a foreign currency.

Question 13

If the exchange rate is allowed to have a direct effect on the consumer price index, then a drop in government spending leads to:

Accepted Answer

A) a larger fall in the level of output under a flexible exchange rate than under a fixed exchange rate regime. 
B) a larger fall in the level of output under a fixed exchange rate than under a flexible exchange rate regime. 
C) an increase in the level of output under a flexible exchange rate regime. 
D) an increase in the level of output under a fixed exchange rate regime.

Question 14

The principal economic loss when a country dollarizes is the loss of:

Accepted Answer

A) seigniorage revenue. 
B) income tax revenue. 
C) monetary stability. 
D) a fixed exchange rate with the dollar.

Question 15

The demand for Canadian goods from other countries is likely to increase if:

Accepted Answer

A) the dollar depreciates. 
B) the dollar appreciates. 
C) the dollar is kept fixed. 
D) None of the above.

Question 16

Assume that the LM curve for a small open economy with a floating exchange rate is given by Y = 200r - 200 + 2 (M / P), while the IS curve is Y = 400 + 3G - 2T + 3NX - 200r. The function for NX is NX = 200 - 100e, where e is the exchange rate. The price level (P) is fixed at 1.0. The international interest rate is r^* = 2.5 percent. a.Using the LM curve, find the equilibrium level of Y in the small open economy, if M = 100. b.Given this value of Y, if G = 100 and T = 100, what must be the equilibrium value of NX? c.If this value of NX is to be achieved, what must be the equilibrium exchange rate, e?

Accepted Answer

The answer of Assume that the LM curve for a...

Question 17

The introduction of automatic teller machines, which reduces the demand for money, will, according to the Mundell-Fleming model with fixed exchange rates, lead to:

Accepted Answer

A) a rise in income and net exports. 
B) no change in income or net exports. 
C) no change in income, but a rise in net exports. 
D) a rise in income, but no change in net exports.

Question 18

The goods produced in Canadian industries may be made more competitive in world markets by:

Accepted Answer

A) appreciating the Canadian currency. 
B) depreciating the Canadian currency. 
C) keeping the exchange rate fixed. 
D) expanding the money supply.

Question 19

Suppose the Minister of Finance cuts government spending in order to balance the budget. Use the Mundell-Fleming model with floating exchange rates to illustrate graphically the short-run impact of the cuts in government spending on the dollar exchange rate and output in Canada. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Accepted Answer

The answer of Suppose the Minister of Finance cuts government...

Question 20

One argument favouring a fixed-exchange-rate system is that it:

Accepted Answer

A) allows monetary policy to be used for stabilizing output and prices. 
B) reduces exchange-rate uncertainty, thereby promoting more international trade. 
C) leads to excessive growth of the money supply. 
D) requires no actions on the part of the central bank to implement.

Exam 13: The Open Economy Revisited: the Mundellfleming Model and the Exchange-Rate Regime