Deck 18: Fixed Exchange Rates and Foreign Exchange Intervention

Question 1

Which one of the following statements is most true?

A) Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline.
B) Any central bank purchase of assets results in an increase in the domestic money supply, while any central bank sale of assets causes the money supply to decline.
C) Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline.
D) Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to increase.
E) Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets does not necessarily affect the money supply.

Answer 1

A

Question 2

Why is it important to understand fixed exchange rates in the modern global economy?

Answer 2

Fixed rates continue to be important for four reasons:
1. Managed floating: Central banks intervene in foreign exchange markets.
2. Regional currency arrangements: Some countries peg their currency to another currency.
3. Developing countries and countries in transition: These countries often attempt to peg their currency to another currency.
4. Lessons of the past: Fixed exchange rates could have a resurgence.

Question 3

Under fixed exchange rate, in general which one of the following statements is the most accurate?

A) The following condition should hold for domestic money market equilibrium: M^s/P = L(R, Y).
B) The following condition should hold for domestic money market equilibrium: M^d/P = L(R, Y).
C) The following condition should hold for domestic money market equilibrium: M^s = L(R, Y).
D) The following condition should hold for domestic money market equilibrium: P = L(R, Y).
E) The following condition should hold for domestic money market equilibrium: R*M^d/P = L(Y).

Answer 3

A

Question 4

The liabilities side of a central bank include

A) deposits held by the private banks.
B) currency in circulation.
C) deposits held by the private banks and currency in circulation.
D) deposits held by the private banks, foreign assets, and currency in circulation.
E) foreign assets and domestic assets.

Question 5

Which of the following is an example of a regional currency arrangement?

A) exchange rate union
B) currency cartel associations
C) free-trade zones
D) most-favored nation status
E) agreement on commercial trade

Question 6

If the central bank does not purchase foreign assets when output increases but instead holds the money stock constant, can it still keep the exchange rate fixed at E^o? Please explain with the aid of a figure.

Question 7

A system of managed floating exchange rates is

A) a system in which governments may attempt to moderate exchange rate movements without keeping exchange rates rigidly fixed.
B) a system in which governments use flexible exchange rates.
C) a system in which governments are forbidden from attempt to moderate exchange rate movements without keeping exchange rates rigidly fixed.
D) a system in which governments need to reach a prior agreement among them before they may attempt to moderate exchange rate movements without keeping exchange rates rigidly fixed.
E) a system in which governments use extensive fiscal policy to discourage exchange rate movements.

Question 8

Please define and give an example of sterilized foreign exchange intervention.

Question 9

If the central bank does not purchase foreign assets when output increases but instead holds the money stock constant, can it still keep the exchange rate fixed at E^o? Please explain.

Question 10

Which one of the following statements is the most true?

A) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign asset implies an increased home money supply.
B) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign asset implies a decreased home money supply.
C) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign asset implies an increased home money demand.
D) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated decrease in the home central bank's foreign asset implies an increased home money supply.
E) If central banks are not sterilizing and the home country has a balance of payments shortage, any associated decrease in the home central bank's foreign asset implies an increased home money supply.

Question 11

Explain risk and liquidity of assets.

Question 12

What are the factors affecting the demand for foreign currency?

Question 13

Which one of the following statements is the most accurate?

A) Under a fixed exchange rate, central bank monetary tools are powerless to affect the economy's money supply.
B) Under a flexible exchange rate, central bank monetary tools are powerless to affect the economy's money supply or its output.
C) Under a fixed exchange rate, fiscal policy tools are powerless to affect the economy's money supply or its output.
D) Under a fixed exchange rate, central bank monetary tools are powerless to affect the economy's money supply or its output.
E) Under a dirty float exchange rate, central bank monetary tools are powerless to affect the economy's money supply or its output.

Question 14

A balance sheet for the central bank of Pecunia is shown below:
Central Bank Balance Sheet
Assets Liabilities
Foreign assets $1,000 Deposits held by private banks $500
Domestic assets $1,500 Currency in circulation $2,000
Please write the new balance sheet if the bank purchased $100 in foreign bonds by writing a check on itself.

Question 15

What is the expected dollar rate of return on dollar deposits with today's exchange rate at $1.10 per euro, next year's expected exchange rate at $1.165 per euro, the dollar interest rate at 10%, and the euro interest rate at 5%?

A) 10%
B) 11%
C) -1%
D) 0%
E) 5%

Question 16

A balance sheet for the central bank of Pecunia is shown below:
Central Bank Balance Sheet
Assets Liabilities
Foreign assets $1,000 Deposits held by private banks $500
Domestic assets $1,500 Currency in circulation $2,000
Please write the new balance sheet if the bank makes a sterilized transaction by selling $100 of foreign assets for domestic currency and then purchasing $100 of domestic assets by writing a check on itself.

Question 17

A balance sheet for the central bank of Pecunia is shown below:
Central Bank Balance Sheet
Assets Liabilities
Foreign assets $1,000 Deposits held by private banks $500
Domestic assets $1,500 Currency in circulation $2,000
Please write the new balance sheet if the bank sells $100 worth of foreign bonds for domestic currency.

Question 18

Central banks often intervene in currency markets. This activity is called

A) managed floating.
B) fixing exchange rates.
C) currency warfare.
D) super-pegging.
E) flexible floating.

Question 19

Which one of the following statements is most true?

A) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in a foreign central bank's claims on the home country implies a decreased foreign money supply.
B) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated decrease in a foreign central bank's claims on the home country implies a decreased foreign money demand.
C) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated decrease in a foreign central bank's claims on the home country implies a decreased foreign money supply.
D) If central banks are not sterilizing and the home country has a balance of payments shortage, any associated decrease in a foreign central bank's claims on the home country implies a decreased foreign money supply.
E) If central banks are not sterilizing and the home country has a balance of payments shortage, any associated decrease in a foreign central bank's claims on the home country implies an increased domestic money supply.

Question 20

A central bank's international reserves include

A) any gold that it owns.
B) any silver that it owns.
C) any gold that it owns and foreign and domestic assets.
D) any silver that it owns and foreign and domestic assets.
E) only foreign and domestic assets.

Question 21

When a country's currency is devalued:

A) output decreases.
B) output increases and the money supply decreases.
C) the money supply decreases.
D) output decreases and the money supply increases.
E) both the output and the money supply increases.

Question 22

Under fixed rates, which one of the following statements is the most accurate?

A) Monetary policy can affect only output.
B) Monetary policy can affect only employment.
C) Monetary policy can affect only international reserves.
D) Monetary policy can not affect international reserves.
E) Monetary policy can only affect money supply.

Question 23

By fixing the exchange rate, the central bank gives up its ability to

A) adjust taxes.
B) increase government spending.
C) influence the economy through fiscal policy.
D) depreciate the domestic currency.
E) influence the economy through monetary policy.

Question 24

Under fixed exchange rate, which one of the following statements is the most accurate?

A) Devaluation causes a decrease in output, a decrease in official reserves, and a contraction of the money supply.
B) Devaluation causes a rise in output, a rise in official reserves, and an expansion of the money supply.
C) Devaluation causes a rise in output and a rise in official reserves.
D) Devaluation causes a rise in output and an expansion of the money supply.
E) Devaluation causes a rise in official reserves, and an expansion of the money supply.

Question 25

Which one of the following statements is the most accurate?

A) Devaluation reflects a deliberate government decision.
B) Depreciation reflects a deliberate government decision.
C) Devaluation reflects a deliberate government decision while depreciation is an outcome of government actions and market forces acting together.
D) Depreciation reflects a deliberate government decision while devaluation is an outcome of government actions and market forces acting together.
E) Devaluation and depreciation have the same meaning and the same causes.

Question 26

Which one of the following statements is the most accurate?

A) Fiscal policy has the same effect on output under fixed and flexible exchange rate regimes.
B) Fiscal policy affects output more under fixed than under flexible exchange rate regimes.
C) Fiscal policy affects output less under fixed than under flexible exchange rate regimes.
D) Fiscal policy cannot affect output under fixed exchange rate but does affect output under flexible exchange rate regimes.
E) Fiscal policy can affect output under fixed exchange rate but does not affect output under flexible exchange rate regimes.

Question 27

Which one of the following statements is the most accurate?

A) Depreciation is a rise in E when the exchange rate is fixed while devaluation is a rise in E when the exchange rate floats.
B) Depreciation is a decrease in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.
C) Depreciation is a rise in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.
D) Depreciation is a rise in E when the exchange rate floats while devaluation is a decrease in E when the exchange rate is fixed.
E) Depreciation is a fall in E when the exchange rate is fixed while devaluation is a fall in E when the exchange rate floats.

Question 28

A balance of payments crisis is best described as

A) a sharp change in interest rates sparked by a change in expectations about the level of imports.
B) a sharp change in foreign reserves sparked by a change in expectations about the future exchange rate.
C) a sharp change in interest rates sparked by a change in expectations about the level of exports.
D) a sharp change in foreign reserves sparked by a change in expectations about the level of imports.
E) a sharp change in foreign reserves sparked by a change in expectations about domestic production.

Question 29

Fiscal Expansion under a fixed exchange has what effect(s) on the economy:

A) the money supply decreases.
B) output decreases.
C) the exchange rate increases.
D) the exchange rate decreases initially but then returns to its original point.
E) output is unchanged.

Question 30

The expectation of future devaluation causes a balance of payments crisis marked by

A) a sharp rise in reserves and a fall in the home interest rate below the world interest rate.
B) a sharp fall in reserves and an even bigger fall in the home interest rate below the world interest rate.
C) a sharp fall in reserves and a rise in the home interest rate above the world interest rate.
D) a sharp rise in reserves and an even greater rise in the home interest rate above the world interest.
E) a sharp rise in reserves and a rise in the home interest rate to the level of the world interest.

Question 31

Under fixed rates, which one of the following statements is the most accurate?

A) Fiscal policy can affect output, employment and international reserves at the same time.
B) Fiscal policy can affect only employment.
C) Fiscal policy can affect only international reserves.
D) Fiscal policy can affect only output and employment.
E) Fiscal employment can affect only output and international reserves.

Question 32

Under fixed exchange rate, which one of the following statements is the most accurate?

A) Devaluation causes a reduction of the money supply.
B) Devaluation has no effect on the stock of money.
C) Devaluation causes an expansion of the money supply.
D) Devaluation causes a reduction in output.
E) Devaluation causes a reduction in official reserves.

Question 33

Which one of the following statements is the most accurate?

A) Fiscal policy has the same effect on employment under fixed and flexible exchange rate regimes.
B) Fiscal policy affects employment less under fixed than under flexible exchange rate regimes.
C) Fiscal policy affects employment more under fixed than under flexible exchange rate regimes.
D) Fiscal policy cannot affect employment under fixed exchange rate but does affect output under flexible exchange rate regimes.
E) Fiscal policy can affect employment under fixed exchange rate regimes, but does not affect output under flexible exchange rate regimes.

Question 34

Which one of the following statements is the most accurate?

A) Revaluation reflects an outcome of government actions and market forces acting together while appreciation reflects a deliberate government decision.
B) Revaluation reflects a deliberate government decision while appreciation is an outcome of government actions and market forces acting together.
C) Revaluation reflects a deliberate government decision while appreciation is an outcome of government actions.
D) Revaluation and appreciation have the same meaning and the same causes.
E) Appreciation reflects a deliberate government decision while revaluation is an outcome of government actions and market forces acting together.

Question 35

Please draw a figure illustrating the actions the central bank must take to maintain a fixed exchange rate following an increase in output.

Question 36

Which one of the following statements is the most accurate?

A) Appreciation is a rise in E when the exchange rate floats while revaluation is a fall in E when the exchange rate is fixed.
B) Appreciation is a fall in E when the exchange rate floats while revaluation is a fall in E when the exchange rate is fixed.
C) Appreciation is a fall in E when the exchange rate is fixed while revaluation is a fall in E when the exchange rate is flexible.
D) Appreciation is a fall in E when the exchange rate floats while revaluation is a rise in E when the exchange rate is fixed.
E) Appreciation is a rise in E when the exchange rate floats while revaluation is a rise in E when the exchange rate is fixed.

Question 37

The expectation of future revaluation causes a balance of payments crisis marked by

A) a sharp rise in reserves and a fall in the home interest rate below the world interest rate.
B) a sharp fall in reserves and an even bigger fall in the home interest rate below the world interest rate.
C) a sharp fall in reserves and a rise in the home interest rate above the world interest rate.
D) a sharp rise in reserves and an even greater rise in the home interest rate above the world interest.
E) a sharp fall in reserves and an unchanged home interest rate.

Question 38

The main reason(s) why governments sometimes chose to devalue their currencies is (are):

A) devaluation makes domestic goods more expensive in relation to foreign goods.
B) devaluation makes domestic services more expensive in relation to foreign services.
C) devaluation increases foreign reserves held by the central bank.
D) devaluation improves the current account and increases foreign reserves held by the central bank.
E) devaluation hurts foreign currencies.

Question 39

Under fixed exchange rate, which one of the following statements is the most accurate?

A) Devaluation causes a rise in output.
B) Devaluation causes a decrease in output.
C) Devaluation has no effect on output.
D) Devaluation causes a rise in output and a decrease in official reserves.
E) Devaluation causes a decrease in output and in official reserves.

Question 40

Which one of the following statements is the most accurate?

A) A devaluation occurs when the central bank lowers the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank raises E.
B) A devaluation occurs when the central bank raises the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank lowers E.
C) Devaluation occurs when the domestic currency price of foreign currency, E, raises and a revaluation occurs when E is lowered.
D) A devaluation occurs when the central bank of the foreign country raises the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank of the foreign country lowers E.
E) A devaluation occurs when the central bank raises the foreign currency price of domestic currency, E, and a revaluation occurs when the central bank lowers E.

Question 41

Define devaluation and use a figure to show the effect of a currency devaluation on the economy.

Question 42

Capital flight

A) increases reserves.
B) is never associated with the expectation of devaluation.
C) may undo expected devaluation.
D) reduces losses during a devaluation scare.
E) decreases reserves and may induce devaluation.

Question 43

Which of the following best describes a deliberate government decision to lower the exchange rate, E?

A) appreciation
B) depreciation
C) revaluation
D) devaluation
E) accumulation

Question 44

Which of the following is not accurate? After introducing the Real as its new currency in 1994, Brazil

A) lost competitiveness in foreign markets since the Real experienced a real appreciation.
B) experienced high domestic interest rates.
C) reduced its annual rate of inflation.
D) experienced bank failures.
E) raised the foreign reserves in its central bank

Question 45

Imperfect asset substitutability assumes:

A) the returns on foreign and domestic currency bonds are the same.
B) the returns on foreign and domestic currency are unrelated.
C) the returns on foreign and domestic currency are not influenced by risk.
D) sterilized intervention proves to be unproductive.
E) the returns on foreign and domestic currency are different, but both are influenced by risk.

Question 46

Use a figure to explain the potential effectiveness of fiscal policy to spur on the economy under a fixed exchange rate.

Question 47

Use a figure to explain how a balance of payments crisis and its hand in capital flight.

Question 48

Currency crises may result from

A) central bank balance sheets with higher liabilities than assets.
B) political upheaval leading to lowering exports.
C) a reconfiguration of central bank balance sheets.
D) speculative attacks on the currency or central banks purchasing excessive amounts of government bonds.
E) depreciation of foreign reserves.

Question 49

Please discuss the difference between the terms devaluation and depreciation.

Question 50

This question concerns the mechanism of a reserve currency standard.
Two countries, X and Y, have two currencies, x and y, fixed to the reserve currency, the U.S. dollar. Suppose the exchange rate between x and the U.S. dollar is 3x per dollar. Suppose the exchange rate between y and the U.S. dollar is 5y per dollar. Please explain (using numbers) the mechanism if the x-y exchange rate was 0.5 x per y.

Question 51

The signaling effect of foreign exchange intervention

A) never has any effect on exchange rates.
B) can alter the market's view of exchange rates independent from the stance of monetary and fiscal policies.
C) cannot cause an immediate exchange rate change when bonds denominated in different currencies are perfect substitutes.
D) never leads to actual changes in monetary or fiscal policy.
E) can alter the market's view of future monetary policies and cause an immediate exchange rate change.

Question 52

Perfect asset substitutability is the assumption that

A) the foreign exchange market is in equilibrium only when expected returns on domestic assets are greater than returns on foreign currency bonds.
B) the foreign exchange market is in equilibrium only when expected returns on foreign currency bonds are greater than returns on domestic assets.
C) the foreign exchange market is in equilibrium only when expected returns on all assets are negative.
D) the foreign exchange market is in equilibrium only when expected returns on domestic assets are equal to returns on foreign currency bonds.
E) the foreign exchange market is in equilibrium only when domestic assets are risk-free.

Question 53

Use a figure to illustrate the ineffectiveness of monetary policy to spur on an economy under a fixed exchange rate.

Question 54

Imperfect asset substitutability exists

A) when it is possible for the expected returns on two assets to be different.
B) when the expected returns on two assets are the same.
C) only when one asset is foreign and the other is domestic.
D) when there is risk in the foreign exchange market.
E) when assets are liquid.

Question 55

Please use a figure to discuss whether or not a devaluation under a fixed exchange rate has the same long-run effect as a proportional increase in the money supply under a floating rate.

Question 56

Briefly describe two systems for fixing the exchange rates of all currencies against each other and the time periods in which they were used.

Question 57

Please describe in detail a self-fulfilling currency crisis.

Question 58

In 1999, following the failure of a $40 billion IMF stabilization plan, Brazil

A) was forced to revalue the Real.
B) experienced an economic boom.
C) was forced to devalue the Real.
D) saw its currency become overvalued.
E) received another loan from the IMF worth $86 billion.

Question 59

In the interest rate parity condition with imperfect substitutes and a risk premium of ρ

A) an increased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.
B) a decreased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.
C) an increased stock of domestic government debt will reduce the difference between the expected returns on domestic and foreign currency bonds.
D) an increased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.
E) a decreased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.

Question 60

Describe some of the causes of the Brazilian 1998-1999 balance of payments crisis.

Question 61

From 1837 and up until the Civil War, the United States adhered to a

A) gold standard.
B) silver standard.
C) bimetallic standard.
D) bronze standard.
E) copper standard.

Question 62

Assume that initially, the risk premium, ρ = 0 and that the domestic and foreign interest rates are given by R = .06, R* = .05. Suppose that the risk premium depends linearly on the difference between domestic government debt, B, and domestic assets of the central bank, A, i.e.
ρ = ρ^(B-A)
Find the new domestic interest rate if a sterilized purchase of foreign assets adjusts A s.t.
(a) B - A = -.01/ ρ_o
(b) B - A = .01/ ρ_o
(c) B - A = .03/ ρ_o

Question 63

Assuming perfect asset substitutability, can sterilized intervention by the central bank be effective? Please discuss.

Question 64

This question concerns the mechanism of a reserve currency standard.
Two countries, X and Y, have two currencies, x and y, fixed to the reserve currency, the U.S. dollar. Suppose the exchange rate between x and the U.S. dollar is 3x per dollar. Suppose the exchange rate between y and the U.S. dollar is 5y per dollar. Please explain (using numbers) the mechanism if the x-y exchange rate was 0.8 x per y.

Question 65

A balance of payments crises under fixed exchange rates occurs when

A) a country runs out of foreign reserves.
B) a country is in a liquidity trap.
C) exports and imports expand beyond some point.
D) marginal returns on foreign exchange investments approach zero.
E) forward currency markets undergo high volatility.

Question 66

Balance of payments crises under fixed exchange rates occur because of

A) government policies that are inconsistent with fixed exchange rates.
B) punitive currency wars.
C) global inflation and trade imbalances due to war.
D) excessive exports and imports that overload the global system.
E) monotonic expansion in global currency volume.

Question 67

Please list the drawbacks of the gold standard.

Question 68

Please briefly describe what is meant by a gold exchange standard.

Question 69

If assets are imperfect substitutes, then a decrease in the amount of domestic currency bonds held by the public will ________ the risk premium and ________ the amount of domestic currency bonds held by the central bank.

A) decrease; leave unchanged
B) increase; decrease
C) increase; increase
D) decrease; decrease
E) leave unchanged; decrease

Question 70

Under the gold standard, if the dollar price of gold is pegged at $35 per ounce and the euro price of gold is pegged at 12 euro per ounce, what is the dollar/euro exchange rate?

Question 71

Under the gold standard, if the dollar price of gold is pegged at $35 per ounce and the dollar/euro exchange rate is set at $2.40 per euro, what must the euro price of gold be pegged at?

Question 72

Describe the mechanism which would take place if the Bank of England decides to increase its money supply by purchasing domestic assets under the gold standard.

Question 73

Assume that initially, the risk premium, ρ = 0 and that the domestic and foreign interest rates are given by R = .06, R* = .05. Suppose that the risk premium depends linearly on the difference between domestic government debt, B, and domestic assets of the central bank, A, i.e.
ρ = ρ^(B-A)
How much will the central bank have to reduce domestic assets A s.t. the domestic interest rate will increase by (a) 1% (b) 4%?

Question 74

If assets are imperfect substitutes, then an increase in the amount of domestic currency bonds held by the public will ________ the risk premium and ________ the amount of domestic currency bonds held by the central bank.

A) increase; leave unchanged
B) increase; decrease
C) increase; increase
D) decrease; decrease
E) leave unchanged; decrease

Question 75

Please show how the country whose currency is the reserve currency can use monetary policy for macroeconomic stabilization. In particular, explain the result if that country doubled its domestic money supply.

Question 76

Imperfect asset substitutability assumes:

A) the returns on foreign and domestic currency bonds are the same.
B) the returns on foreign and domestic currency are unrelated.
C) the returns on foreign and domestic currency are not influenced by risk.
D) Sterilized intervention proves to be unproductive.
E) the returns on foreign and domestic currency are different, but both are influenced by risk.

Question 77

Use a figure to show the effect of a sterilized central bank purchase of foreign assets under the imperfect asset substitutability assumption.

Question 78

Briefly discuss the main advantage of the bimetallic standard over the gold standard.

Question 79

Does the signalling effect of foreign exchange intervention support or refute the claim that assets cannot be perfect substitutes if sterilized intervention is going to have any effect? Please explain.

Question 80

From the figure below, please provide an explanation for the large growth rate of international reserves held by developing countries and the sharp decline in the 1980s.