Deck 21: Exchange Rate Regimes

Question 1

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 devaluation?

A) The real exchange rate will be permanently lower in the medium run.
B) The real exchange rate will be permanently higher 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) The real exchange rate will be the same in the medium run.

Answer 1

The real exchange rate will be the same in the medium run.

Question 2

Based on your understanding of the AS- AD open economy model, a devaluation causes which of the following in the short run?

A) An increase in the price level.
B) An increase in net exports.
C) An increase in output.
D) All of the above.
E) None of the above.

Answer 2

All of the above.

Question 3

During the EMS crisis in 1992:

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

Answer 3

the United Kingdom and Italy abandoned the system.

Question 4

Use the following information to answer the question(s) below:
The exchange rate between the Australian dollar and the British pound is 0.65 (i.e., 0.65 pounds per Australian dollar). In the U.K., the price level is 1.0 and the interest rate is 15%. In Australia, the price level is 0.5 and the interest rate is 10%. The inflation rate in both countries is zero.
Refer to the information above. The price of Australian goods measured in pounds is:

A) 0.325 U.K. goods.
B) 0.125 U.K. goods.
C) 0.425 U.K. goods.
D) 0.525 U.K. goods.
E) 0.225 U.K. goods.

Question 5

Assume that exchange rates are flexible and that the future expected exchange rate 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.
E) The effects on the current nominal exchange rate depend on future current account balances.

Question 6

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

A) An increase in its trade surplus.
B) A real appreciation of its currency.
C) An increase in its price level.
D) All of the above.
E) None of the above.

Question 7

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) Both the real and the nominal exchange rate will decrease.
C) The nominal exchange rate will decrease and the real exchange rate will increase.
D) The nominal exchange rate will decrease with no change in the real exchange rate.
E) No change in either the nominal or real exchange rate.

Question 8

Under the Gold Standard:

A) nominal exchange rates were fixed.
B) real exchange rates were fixed.
C) nominal interest rates were fixed.
D) nominal exchange rates could float.
E) real interest rates were fixed.

Question 9

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) Revaluation.
B) Devaluation.
C) Dollarisation.
D) Flexible exchange rates.
E) Crawling peg.

Question 10

Suppose there are two countries that decide to peg the exchange rate at its current rate, which of the following must be true in the short run?

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) The real exchange rates between the two countries will be equal.
E) The interest rates must be equal in the two countries.

Question 11

In a fixed exchange rate regime, an increase in the price level will cause:

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

Question 12

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 crawling peg.
B) A revaluation.
C) A currency board.
D) The EMS.
E) A flexible exchange rate regime.

Question 13

Part of the reason that triggered the 1992 EMS Crisis was that:

A) France allowed the franc to depreciate too rapidly.
B) member states built up too large a budget deficit.
C) member states had to raise their interest rates to maintain their EMS parities.
D) member states had to lower their interest rates to maintain their EMS parities.
E) Italy allowed the lira to appreciate too rapidly.

Question 14

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

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

Question 15

Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level of output. Suppose that government spending decreases. Given this information, we know that this fiscal contraction will cause:

A) the real exchange rate to be unchanged in the medium run.
B) the real exchange rate only decreases in the medium run if foreign prices rise.
C) the real exchange rate to be permanently higher in the medium run.
D) the effects of this fiscal contraction on the real exchange rate will be ambiguous in the medium run.
E) the real exchange rate to be permanently lower in the medium run.

Question 16

After continuing crises in 1993, the EMS countries:

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

Question 17

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

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

Question 18

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

A) A devaluation causes a nation with fixed exchange rates to lose credibility in the medium run, driving its interest rate higher.
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) Devaluations cause relatively slow adjustments.
D) Devaluations allow output to return to its natural level quickly.
E) Both B and C.

Question 19

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

Question 20

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

A) a housing bubble.
B) a real appreciation of its currency.
C) higher interest rates.
D) a default on its national debt.
E) lower unemployment.

Question 21

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

A) a decrease in the pegged value of the domestic currency.
B) a decision to let the currency float.
C) a decrease in the foreign price level.
D) a decrease in the domestic price level.
E) a decrease in the pegged value of the foreign currency.

Question 22

t n+ The expected future nominal exchange rate in the medium run, E e, is assumed to be the
Nominal exchange rate at which:

A) one unit of foreign currency exchanges for one unit of domestic currency.
B) domestic and foreign price levels are equal.
C) the current account is in balance.
D) the domestic currency is risk- free.
E) the future rate of appreciation or depreciation is constant.

Question 23

Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level of output. Now suppose that households as a result of an increase in consumer confidence increase consumption. Given this information, we know that:

A) the real exchange rate only increases in the medium run if foreign prices fall.
B) the real exchange rate will be permanently lower in the medium run.
C) the real exchange rate will be unchanged in the medium run.
D) the real exchange rate will be permanently higher in the medium run.
E) the effects of this consumption increase on the real exchange rate will be ambiguous in the medium run.

Question 24

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 foreign price level.
B) A decrease in the domestic interest rate.
C) A devaluation of the currency.
D) An increase in the price level.
E) An increase in money supply.

Question 25

Assume that the interest parity condition holds, the future expected exchange rate is constant, the current nominal exchange rate is 2.2, the one- year foreign interest rate is 7% and the one- year domestic interest rate is 4%. One could conclude that:

A) financial market participants expect that the exchange rate will increase by 4% over the coming year.
B) financial market participants expect that the exchange rate will increase by 3% over the coming year.
C) financial market participants expect that the exchange rate will decrease by 3% over the coming year.
D) financial market participants expect that the exchange rate will decrease by 4% over the coming year.
E) financial market participants expect the exchange rate to remain unchanged over the coming year.

Question 26

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) An increase in investment.
B) An increase in domestic stock prices.
C) An increase in demand for the country's currency.
D) An increase in interest rates.
E) An announcement by the central bank that a large devaluation will occur in the near future.

Question 27

Use the following information to answer the question(s) below:
The exchange rate between the Australian dollar and the British pound is 0.65 (i.e., 0.65 pounds per Australian dollar). In the U.K., the price level is 1.0 and the interest rate is 15%. In Australia, the price level is 0.5 and the interest rate is 10%. The inflation rate in both countries is zero.
Refer to the information above. The real exchange rate, from the Australian perspective, is:

A) 0.325.
B) 0.525.
C) 0.225.
D) 0.125.
E) 0.425.

Question 28

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) The interest rate falls as the economy adjusts by itself.
B) Net exports will increase as the economy adjusts to this situation.
C) Domestic goods will become less competitive as the economy adjusts by itself.
D) Prices will decrease over time until Y = Yn.
E) A decrease in the pegged value of the domestic currency will cause a leftward shift of the AD curve.

Question 29

An adjustment of central parities in the EMS is called a:

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

Question 30

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) A revaluation of the currency.
B) A devaluation of the currency.
C) An increase in the price level.
D) An increase in the domestic interest rate.
E) A decrease in the foreign price level.

Question 31

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

A) 1997.
B) 2002.
C) 1992.
D) 1999.
E) 2000.

Question 32

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 worsening trade position.
B) an increase in the real exchange rate.
C) a decrease in domestic demand.
D) All of the above.
E) None of the above.

Question 33

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

A) Each country could conduct its own, independent fiscal policy.
B) Each countries could devalue its currency to increase domestic output.
C) Each country could conduct its own, independent monetary policy.
D) Countries could more easily erect barriers to trade.
E) Exchange rate uncertainty within the common currency area would be eliminated.

Question 34

Which of the following will occur in the medium run as a result of a revaluation?

A) A decrease in net exports.
B) A decrease in output.
C) A decrease in the price level.
D) All of the above.
E) None of the above.

Question 35

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

A) Increase government spending and devalue the currency.
B) Decrease government spending.
C) Increase government spending and revalue the currency.
D) Increase government spending.
E) Revalue the currency.

Question 36

Suppose that policy makers decide to revalue the currency, such an action generally represents:

A) a decision to let the currency float.
B) an increase in the domestic price level.
C) a decrease in the pegged value of the foreign currency.
D) an increase in the pegged value of the domestic currency.
E) a decrease in the foreign price level.

Question 37

Assume that policy makers are pursuing a fixed exchange rate regime and 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 lower in the medium run.
B) The real exchange rate will be unchanged in the medium run.
C) The nominal exchange rate will initially fall in the short run and then increase in the medium run.
D) The effects of this revaluation on the real exchange rate will be ambiguous in the medium run.
E) The real exchange rate will be permanently higher in the medium run.

Question 38

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) Convince trading partners to decrease their interest rates.
B) Decrease the domestic price level.
C) Decrease stock prices.
D) Decrease the domestic interest rate.
E) Convince trading partners to decrease their price levels.

Question 39

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 devaluation in the future. The interest rate parity condition will be maintained if which of the following policy actions are taken in the current period?

A) A decrease in the domestic interest rate.
B) An increase in the domestic interest rate.
C) An increase in taxes.
D) A decrease in the pegged value of the domestic currency.
E) A decrease in government spending.

Question 40

The European Central Bank is located in which country?

A) France.
B) Italy.
C) The United Kingdom.
D) Germany.
E) Spain.

Question 41

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

Question 42

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 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

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

Question 45

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 46

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

Question 47

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

Question 48

Assume that exchange rates are flexible and that the future expected exchange rate in one year is not constant. Suppose that individuals now expect that the domestic central bank will pursue contractionary monetary policy in one year. This expected future monetary contraction 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.
E) The effects on the current nominal exchange rate depend on future current account balances.

Question 49

Explain why the nominal exchange rate must overshoot in the short run when the central bank pursues monetary expansion by lowering the price target?

Question 50

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 51

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

Question 52

When we no longer assume that the future expected exchange rate 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 53

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 54

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