Deck 19:Exchange Rate Policy and the Central Bank

Question 1

If the inflation rate in country A is 3.5% and the inflation rate in country B is 3.0%, we should expect the percentage change in the number of units of country A's currency per unit of country B's currency to be:

A) +0.5%.
B) -0.5%.
C) +16.7%.
D) +6.5%.

Answer 1

A

Question 2

In the long run, a country's exchange rate is determined by:

A) domestic monetary.
B) purchasing power parity.
C) the domestic inflation rate.
D) supply and demand.

Answer 2

B

Question 3

Assuming the free flow of capital across borders, if country A wants to fix its exchange rate with country B, then:

A) country A's inflation rate will have to match country B's.
B) country A's monetary policy must be conducted so the inflation rate in country A matches the inflation rate in country B.
C) country A's monetary policy will not be able to be used to address domestic issues.
D) all of the answers given are correct.

Answer 3

D

Question 4

Within the United States, every city has:

A) a fixed exchange rate with every other city.
B) a floating exchange rate with every other city.
C) an independent monetary policy.
D) their own currency board.

Question 5

Which of the following statements is incorrect?

A) A country cannot be open to international capital flows, control its domestic interest rate and fix its exchange rate.
B) A country can be open to international capital flows and control its own domestic interest rate but it can't fix its exchange rate.
C) A country can be open to international capital flows, control its domestic interest rate, and fix its exchange rate.
D) A country can be open to international capital flows and fix its exchange rate but could not also control its own domestic interest rate.

Question 6

Let if be the interest rate being paid on a foreign bond, and let i be the interest rate being paid for a domestic bond; let P be the price of the domestic bond and let Pf be the price of the foreign bond. If exchanges rates are fixed and the bonds are equal in terms of risk:

A) if = i.
B) P = Pf times units of domestic currency/unit of foreign currency.
C) the expected return from the foreign bond = the expected return from the domestic bond.
D) all of the answers given are correct.

Question 7

The United States would be characterized as having:

A) a controlled domestic interest rate, a closed capital market and a flexible exchange rate.
B) a controlled domestic interest rate, an open capital market and a flexible exchange rate.
C) no control over the domestic interest rate, an open capital market and a flexible exchange rate.
D) a controlled domestic interest rate, an open capital market and a fixed exchange rate.

Question 8

Purchasing power parity implies:

A) a basket of goods should sell for the same price in all countries, even if trade barriers exist.
B) a basket of goods will sell for the same price in all countries as long as there are no trade barriers is a free flow of capital across borders.
C) a basket of goods cannot sell for the same price in different countries due to the different wage rates.
D) as long as all goods and services are traded freely across international boundaries, one unit of domestic currency should buy the same basket of goods anywhere in the world.

Question 9

If capital flows freely between countries and a country has a fixed exchange rate, one thing you know is that the country:

A) exports more than it imports.
B) must have ample gold reserves.
C) cannot have a discretionary monetary policy.
D) must be running large trade deficits

Question 10

When arbitrage occurs across countries with flexible exchange rates and when the bonds in each country are identical and there are no barriers to capital flows:

A) the interest rates on the bonds will be identical.
B) the prices of the bonds will be identical.
C) the inflation rates in each country will be identical.
D) none of the answers provided is correct.

Question 11

If inflation in country A exceeds inflation in country B, we can express the percentage change in the units of currency of country A per unit of currency of country B as:

A) the inflation rate in country B - the inflation rate in country A.
B) the inflation rate in country A - the inflation rate in country B.
C) the inflation rate in country A times the inflation rate in country B.
D) the inflation rate in country A divided by the inflation rate in country B.

Question 12

Purchasing power parity is a good theory of explaining exchange rate behavior:

A) over very short periods.
B) over periods lasting six to twelve months.
C) over very long periods, such as decades.
D) over both long and short periods.

Question 13

If the bonds of two different countries are identical, their expected returns will:

A) be equal if capital flows freely internationally.
B) always be equal.
C) be equal only if the exchange rate between the two countries is fixed.
D) be equal only if the inflation rate is the same in each country.

Question 14

Assuming the free flow of capital across borders, which of the following statements is most correct?

A) A central bank can have both a fixed exchange rate and an independent inflation policy.
B) A central bank cannot have both a fixed exchange rate and an independent inflation policy.
C) The central banks of most industrialized countries focus on fixed exchange rates.
D) While most central banks of industrialized countries favor fixing exchange rates, their primary concern is on domestic inflation.

Question 15

International capital mobility:

A) contributes to the rigidity of exchange rates.
B) contributes to the equalization of expected returns across countries.
C) eliminates arbitrage opportunities.
D) makes interest rates equal across countries.

Question 16

If inflation in country A exceeds inflation in country B, purchasing power parity implies that:

A) the currency of country B should depreciate relative to the currency of country A.
B) the inflation rate in country B will rise to match the inflation rate in country A.
C) the currency of country A will depreciate relative to the currency of country B.
D) the inflation rate in country A will fall to match the inflation rate in country B.

Question 17

Consider the following: an investor in the U.S. is pondering a one-year investment. She can purchase a domestic bond for $1,000 that has an interest rate of i or she can purchase a bond in England for 1,500 British pounds (£) that pays an interest rate of if. The current exchange rate is $1.50/£ . She considers the bonds to be of equal risk. If i = if, the expected returns are not equal. What do you know?

A) The exchange rate is fixed between the U.S. and Britain
B) The bonds initially sold for different prices
C) Arbitrage doesn't work
D) The exchange rate must be flexible

Question 18

When arbitrage occurs across countries with a flexible exchange rate and when the bonds in each country are identical and there are no barriers to capital flows then the:

A) interest rates on the bonds will be identical.
B) expected return on the bonds will be identical.
C) inflation rates in each country will be identical.
D) prices of the bonds will be identical.

Question 19

If a U.S. dollar currently purchases 1.3 Canadian dollars and the inflation rate in Canada over the next year is 5 percent while it is 2 percent in the U.S., we should expect a U.S. dollar to purchase:

A) 1.365 Canadian dollars.
B) 1.262 Canadian dollars.
C) 1.300 Canadian dollars.
D) 1.339 Canadian dollars.

Question 20

In the short run, a country's exchange rate is determined by:

A) monetary policy.
B) purchasing power parity.
C) the domestic inflation rate.
D) supply and demand.

Question 21

If the Fed decides to maintain a fixed euro/dollar exchange rate when they purchase euros:

A) they increase the number of dollars.
B) downward pressure is put on domestic interest rates.
C) the domestic money supply increases.
D) all of the answers given are correct.

Question 22

Capital controls:

A) can be controls on capital inflows.
B) can only be controls on capital outflows.
C) can be controls on capital inflows or outflows.
D) must be controls on both capital inflows and outflows in order to be effective.

Question 23

An open-market purchase of foreign bonds to increase a central bank's international reserves:

A) increases the central bank's liabilities and assets.
B) decreases the central bank's assets and liabilities.
C) increases the central bank's assets but decreases its liabilities.
D) increases the central bank's liabilities and decreases its assets.

Question 24

If domestic residents are restricted in their ability to purchase foreign assets then their government is imposing:

A) controls on capital inflows.
B) controls on capital outflows.
C) controls on both capital inflows and outflows.
D) fixed exchange rates.

Question 25

During the 1990s, the country of Chile required foreigners wishing to invest in the country to make a one-year, zero-interest deposit in the Chilean central bank equal to at least 20 percent of the investment. This is an example of:

A) a capital outflow control.
B) a capital inflow control.
C) an exchange rate mechanism.
D) a currency board.

Question 26

Which of the following would be an example of a capital outflow control?

A) Mexico limiting the number of U.S. dollars an American can bring into the country
B) Mexico excludes foreigners from purchasing short-term debt
C) Mexico limiting the number of pesos its citizens can take out of the country
D) All of the answers given would be examples of capital outflow controls

Question 27

If the Fed desired to fix the euro/dollar exchange rate, they would have to:

A) get the European Central Bank to also agree to fixed exchange rates.
B) maintain ample reserves of dollars.
C) be willing to exchange dollars for euros whenever anyone asked.
D) impose capital controls.

Question 28

If the Fed decides to maintain a fixed euro/dollar exchange rate when they sell euros:

A) there will be pressure on domestic interest rates to increase.
B) the domestic money supply will increase.
C) this will increase banking system reserves.
D) they will have to impose capital controls.

Question 29

The impact on the foreign exchange market for dollars resulting from the Fed selling euros will be:

A) a decrease in the demand for dollars.
B) a decrease in the supply of dollars.
C) an increase in the supply of dollars.
D) a decrease in the interest rate in the U.S.

Question 30

Most economists view capital controls:

A) unfavorably.
B) unfavorably, emphasizing their harmful effects on developing countries.
C) favorably, since this is the main way for countries to exploit their comparative advantage.
D) favorably, since having them makes capital markets more efficient.

Question 31

If foreigners are restricted in their ability to buy investments in a country then that government is imposing:

A) controls on capital inflows.
B) controls on capital outflows.
C) controls on both capital inflows and outflows.
D) fixed exchange rates.

Question 32

If foreigners are restricted in their ability to sell investments in a country then that government is imposing:

A) controls on capital inflows.
B) controls on capital outflows.
C) controls on both capital inflows and outflows.
D) fixed exchange rates.

Question 33

A foreign exchange intervention by a central bank affects the value of a country's currency if it:

A) alters banking system reserves.
B) leaves domestic interest rates unchanged.
C) results in a fixed exchange rate.
D) alters banking system reserves and it changes domestic interest rates.

Question 34

The Fed holds its euro reserves primarily in the form of:

A) euro currency.
B) a weighted portfolio of European government bonds.
C) German government bonds.
D) international mutual funds.

Question 35

A country announces capital outflow controls that will take effect in three months. This announcement will likely:

A) stabilize the country's exchange rate.
B) attract significant amounts of foreign investors.
C) result in a significant appreciation of the country's currency.
D) result in a significant depreciation in the country's currency.

Question 36

If the Fed decides to control the euro/dollar exchange rate:

A) they will also have to control the domestic interest rate.
B) they will have to control the amount of banking system reserves.
C) the market will determine the interest rate.
D) they will have to control the domestic rate of inflation or it won't work.

Question 37

If the Fed were to enter the foreign exchange market and purchase euros, the impact on domestic banking reserves would be:

A) the opposite of what it would be with an open market purchase.
B) domestic banking reserves would decrease.
C) the same as it would be with an open market purchase.
D) uncertain.

Question 38

If interest rates in the U.S. increases relative to interest rates in Europe:

A) the demand for dollars on the foreign exchange market would increase.
B) the supply of euros on the foreign exchange market would increase.
C) the price of U.S. assets should increase.
D) all of the answers given are correct.

Question 39

A country that frequently uses capital controls:

A) increases the risk for foreign investors.
B) decreases the risk for foreign investors.
C) should see lower interest rates on its domestic bonds and lower prices.
D) will attract more investment.

Question 40

Reserves in the banking system will increase if the Fed:

A) buys euros or sells dollars.
B) sells euros or buys dollars.
C) sells euro-dominated bonds and exchanges the euros for dollars.
D) sells euro-dominated bonds and keeps the euros from the sale.

Question 41

A U.S. resident purchases a bond issued by the Canadian government. If the Canadian dollar appreciates relative to the U.S. dollar over the term of the bond, the U.S. investor will:

A) see a higher return on her investment as a result.
B) see a lower return on her investment as a result.
C) not see her return affected since exchange rates are flexible.
D) none of the answers provided is correct.

Question 42

Suppose that you purchase a Korean government bond and the number of won needed to purchase one dollar increases. Your return on the bond:

A) decreases by the amount of the dollar's appreciation.
B) decreases by more than the amount of the dollar's appreciation.
C) decreases by less than the amount of the dollar's appreciation.
D) increases by the amount of the dollar's appreciation.

Question 43

A foreign exchange intervention that alters the domestic monetary base is:

A) sterilized.
B) unsterilized.
C) not likely to change domestic interest rates.
D) impossible.

Question 44

A country with a fixed exchange rate policy and free cross-border capital flows that is experiencing an economic slowdown will find:

A) their central bank will reduce the domestic interest rate in order to fend off the slowdown.
B) their currency will depreciate to stimulate exports.
C) their corporate equities will become more attractive to foreign investors.
D) monetary policy in not available as an economic stabilization tool.

Question 45

When Argentina fixed the exchange rate of their peso to the U.S. dollar, one outcome was:

A) Argentinean central bankers regained control of their domestic interest rate.
B) Argentinean central bankers were finally able to focus their attention on domestic monetary policy.
C) Argentinean central bankers effectively gave control of their domestic interest rate to the FOMC.
D) Argentineans began using the U.S. dollar for all of their transactions.

Question 46

Any central bank policy that influences the domestic interest rate will:

A) have no effect on the exchange rate if exchange rates are flexible.
B) have an effect on the exchange rate.
C) not impact the supply of and demand for the domestic currency if exchange rates are flexible.
D) be compatible with fixed exchange rates.

Question 47

A speculative attack on a country with a fixed exchange rate occurs when:

A) financial market participants believe the government will have to devalue its currency.
B) financial market participants believe the government has a large excess of international reserves.
C) financial market participants believe the currency is undervalued.
D) the country converts its gold reserves into foreign exchange.

Question 48

In September of 2000, the Federal Reserve Bank of New York sold dollars in exchange for euro. To keep the federal funds rate on target, the Open Market desk:

A) sold U.S. Treasury bonds.
B) bought U.S. Treasury bonds.
C) bought dollars.
D) sold dollars.

Question 49

Speculative attacks:

A) can only result from irresponsible fiscal policy.
B) can always be stopped by the country's central bank if they act quickly.
C) can be triggered even when domestic policymakers are acting responsibly.
D) are illegal, and if caught, speculators are assessed large fines.

Question 50

All of the following are associated with a fixed exchange rate policy except:

A) sacrificing control of the domestic inflation rate.
B) higher import prices.
C) the need to maintain ample international reserves.
D) it means importing monetary policy.

Question 51

In 1997, there was a speculative attack on the Thai baht. This resulted from the:

A) belief by speculators that the Thai central bank had an oversupply of U.S. dollar reserves.
B) belief by speculators that the Thai central bank didn't have sufficient U.S. dollar reserves to maintain the current fixed rate.
C) revelation that the Thai central bank had converted its gold reserves into foreign exchange.
D) overthrow of the Thai president and the central bank.

Question 52

Which of the following statements is incorrect?

A) A foreign exchange intervention affects the value of a country's currency by changing domestic interest rates.
B) Any central bank policy that influences the domestic interest rate will affect the exchange rate.
C) Higher U.S. interest rates would likely result in an appreciation of the U.S. dollar.
D) Sterilized changes in foreign exchange reserves alter a country's monetary base.

Question 53

Assume that the Fed performs a foreign exchange intervention in which it does nothing except buy German government bonds. One result of this will be that:

A) the dollar depreciates.
B) the euro depreciates.
C) both the dollar and the euro depreciate.
D) the dollar appreciates and the euro depreciates.

Question 54

Fixing an exchange rate between two countries makes the most sense when:

A) the countries macroeconomic fluctuations are positively correlated.
B) the countries macroeconomic fluctuations are negatively correlated.
C) the countries' macroeconomic fluctuations are uncorrelated.
D) one country has a lot of international reserves and the other doesn't.

Question 55

A fixed exchange rate policy:

A) decreases central bank policy accountability and transparency.
B) strengthens domestic interest rate policy.
C) will likely make domestic inflation more volatile.
D) imports monetary policy.

Question 56

An advantage of fixed exchange rates for a country that suffers from bouts of high inflation is:

A) it makes imports less expensive.
B) it establishes a credible low inflation policy.
C) it unties policymakers' hands so they can alter the reserves of the banking system as needed.
D) policymakers will have increased control over domestic interest rates.

Question 57

If the Fed were to purchase euros for dollars and at the same time sell U.S. Treasury securities in the open market, this would be an example of:

A) an unsterilized foreign exchange intervention.
B) the Fed not changing their balance sheet at all.
C) a sterilized foreign exchange intervention.
D) the Fed altering the domestic monetary base.

Question 58

A sterilized foreign exchange intervention would:

A) alter the asset side of a central bank's balance sheet but leave the domestic monetary base unchanged.
B) alter the liability side of the central bank's balance sheet but leave the asset side unchanged.
C) leave the central bank's balance sheet unchanged.
D) not alter the central bank's holdings of international reserves.

Question 59

A foreign exchange intervention that does not alter the domestic monetary base is:

A) sterilized.
B) unsterilized.
C) likely to change domestic interest rates.
D) impossible.

Question 60

Which of the following statements is most correct?

A) A sterilized foreign exchange intervention will alter the composition of a central bank's assets and alter commercial bank reserves.
B) A sterilized foreign exchange intervention will not alter the composition of a central bank's assets.
C) An unsterilized foreign exchange intervention will alter commercial bank reserves.
D) A sterilized foreign exchange intervention will leave the central bank's holdings of foreign reserves unchanged.

Question 61

Most economic historians believe that:

A) if more countries would have been on the gold standard the Great Depression would have been averted.
B) the gold standard didn't play a major role in the Great Depression.
C) the gold flows played a central role in spreading the Great Depression.
D) countries that held on to the gold standard recovered from the Great Depression the quickest.

Question 62

If the U.S. were to revert to a gold standard, trade deficits would:

A) result in gold reserves in the U.S. decreasing.
B) result in lower domestic interest rates.
C) quickly disappear.
D) result in high inflation.

Question 63

One reason a country would be better off fixing its exchange rate is if:

A) it has a strong reputation for controlling inflation on its own.
B) it lacks ample foreign exchange reserves.
C) it is well-integrated with the economy of the country to whose currency its currency is fixed.
D) its own macroeconomic characteristics are inversely correlated with the macroeconomic characteristics of the country to whose currency its currency is fixed.

Question 64

Which of the following statements best completes the following sentence; "Prior to World War I, when the U.S. was on the gold standard, inflation in the U.S…."?

A) averaged 3.5 percent per year but was highly variable.
B) averaged less than one percent per year and was highly variable.
C) averaged less than one percent per year and was stable.
D) averaged 3.5 percent per year and was stable.

Question 65

In Hong Kong, the monetary authority can only increase the monetary base if they accumulate more U.S. dollars because:

A) the currency of Hong Kong is the U.S. dollar.
B) the monetary authority in Hong Kong operates a currency board where its sole objective is to fix the exchange rate between its currency and the U.S. dollar.
C) the IMF required Hong Kong to peg its currency to the U.S. dollar in order to obtain a loan.
D) Hong Kong has received substantial funding from the U.S. Treasury and the loans were conditional on maintaining the value of the Hong Kong currency.

Question 66

The Breton Woods System was an agreement that:

A) required each participating country to peg their currency to the U.S. dollar.
B) required each participating country to abolish all trade barriers.
C) required each participating country to stay on the gold standard.
D) standardized tariffs across all participating countries.

Question 67

Under the Bretton Woods System each participating country had to:

A) be willing to exchange their own currency for gold.
B) hold ample reserves of currency of each of the participating countries.
C) stand ready to exchange its own currency for U.S. dollars at a fixed exchange rate.
D) adopt capital controls.

Question 68

The International Monetary Fund's primary role under the Bretton Woods System was to be:

A) the issuer of gold.
B) the clearinghouse for international transactions.
C) a short-term lender for countries with an excess of imports over exports.
D) the arbiter of trade disputes.

Question 69

Which of the following best completes the sentence; "Under a gold standard a central bank … "?

A) can have too much gold.
B) can have too little gold but never have too much.
C) wants to keep their gold reserves fixed.
D) will have gold reserves depleted when exports exceed imports.

Question 70

In April 1991, Argentina adopted a currency board primarily to address the problem of:

A) slow growth.
B) high interest rates.
C) large trade surpluses.
D) triple-digit inflation.

Question 71

The International Monetary Fund was created as a part of:

A) the United Nations.
B) the Bretton Woods System.
C) the European Monetary Union.
D) the Federal Reserve System.

Question 72

China has used its current account surplus to:

A) buy stocks on the New York Stock Exchange.
B) buy German government and agency securities.
C) buy U.S. government and agency securities.
D) make loans to foreigners.

Question 73

Which of the following statements is most correct?

A) A fixed exchange rate policy is a lack of a monetary policy.
B) A fixed exchange rate policy is appropriate for a country that lacks a central bank.
C) A fixed exchange rate policy is only appropriate for countries with little international reserves.
D) A fixed exchange rate policy is a monetary policy.

Question 74

The Bretton Woods System failed in 1971 due to:

A) high rates of inflation in the U.S.
B) greater mobility of capital across international borders.
C) the desire on the part of participating countries to have an independent monetary policy.
D) all of the reasons given are correct.

Question 75

Most economists do not advocate a return to the gold standard because:

A) it forces the central bank to fix the price of something we don't really care about while other prices can fluctuate a lot.
B) past willingness to exit the Gold Standard casts doubt on the credibility of committing to it again.
C) inflation will depend on the rate that gold is mined.
D) all of the answers given are correct.

Question 76

A country that suffers from bouts of high inflation and wants to fix its exchange rate should tie its currency to the currency of a:

A) country with a strong reputation for low inflation.
B) larger country.
C) country with similar inflation performance.
D) country that is still on the gold standard.

Question 77

Only two exchange rate regimes can be considered hard pegs. These are:

A) currency boards and dollarization.
B) dollarization and managed floating.
C) flexible exchange rates and currency boards.
D) the gold standard and inflation targeting.

Question 78

Fixed exchange rate regimes include each of the following, except:

A) the Bretton Woods exchange rate system.
B) exchange rate pegs.
C) dollarization.
D) currency boards.

Question 79

When a country operates with a currency board, the central bank's sole objective is to:

A) focus on domestic monetary policy.
B) maintain the domestic interest rate.
C) maintain the exchange rate.
D) maintain the target inflation rate.

Question 80

If the U.S. were to revert to a gold standard, trade deficits would:

A) result in gold reserves in the U.S. increasing.
B) result in higher domestic interest rates.
C) quickly disappear.
D) result in high inflation.