Question 1

The combination of currency and bank deposits at the central bank is called the money supply.

Accepted Answer

The money supply typically includes currency in circulation (notes and coins) and various types of deposits at commercial banks, not just deposits at the central bank. Deposits at the central bank are part of the central bank's liabilities and are mainly held by commercial banks as reserves.

Question 2

The figure below shows an IS-LM-FE model for an economy with fixed exchange rates. Initially the economy was at point A, a triple intersection. Here, the FE curve is flatter than the LM curve. If monetary authorities are unable to sterilize, the interest rate will end up: A)at i₁. B)above i₁. C)between i₁ and i₀. D)at i₀.

Accepted Answer

The answer of The figure below shows an IS-LM-FE model...

Question 3

Assume that the exchange rates are fixed. When money demand is less sensitive to interest rate changes than are international capital flows, _____ policy will be _____ effective than when money demand is more sensitive to interest changes than are international capital flows.
A)expansionary fiscal; more
B)expansionary fiscal; less
C)expansionary monetary; more
D)sterilized intervention; more

Accepted Answer

When money demand is less sensitive to interest rate changes than are international capital flows, expansionary fiscal policy will be more effective. This is because expansionary fiscal policy will lead to a decrease in interest rates, which will make it more attractive for domestic residents to hold domestic money. As a result, the demand for domestic money will increase, which will lead to an appreciation of the domestic currency. This appreciation will make it more expensive for domestic residents to purchase foreign goods and services, which will lead to a decrease in imports. The decrease in imports will lead to an increase in net exports, which will help to boost economic growth.

Question 4

Under perfect capital mobility and fixed exchange rates, expansionary _____ is a futile attempt because the _____.
A)fiscal policy; LM curve effectively is vertical.
B)monetary policy; LM curve effectively is the same as the FE curve.
C)fiscal policy; interest rate does not change.
D)monetary policy; IS curve will shift to the left.

Accepted Answer

Under perfect capital mobility and fixed exchange rates, the LM curve effectively becomes the same as the FE (foreign exchange) curve. Therefore, any attempt at expansionary monetary policy (shifting the LM curve) will ultimately result in a change in the exchange rate, not output or interest rates. As a result, it is a futile attempt to use monetary policy to stimulate the economy.

Question 5

The figure below shows an IS-LM-FE model for an economy with fixed exchange rates. Initially the economy was at point A, a triple intersection. Here, the FE curve is flatter than the LM curve.  In order to maintain the fixed exchange rate, at point B monetary authorities must:
A)buy domestic government bonds.
B)sell domestic currency.
C)buy domestic currency.
D)sell domestic government bonds.

Accepted Answer

The answer of The figure below shows an IS-LM-FE model...

Question 6

According to the assignment rule, which of the following policy mixes is appropriate for a country with high unemployment, a balance of payments deficit, and fixed exchange rates?
A)Contractionary fiscal policy and contractionary monetary policy
B)Contractionary fiscal policy and expansionary monetary policy
C)Expansionary fiscal policy and expansionary monetary policy
D)Expansionary fiscal policy and contractionary monetary policy

Accepted Answer

With high unemployment and a balance of payments deficit, the economy needs expansionary fiscal policy to increase demand and generate employment, and fixed exchange rates need contractionary monetary policy to avoid creating an inflationary pressure by increasing the money supply. Therefore, expansionary fiscal policy and contractionary monetary policy are the most appropriate policy mix in this case.

Question 7

The figure below shows an IS-LM-FE model for an economy with fixed exchange rates. Initially the economy was at point A, a triple intersection. Here, the FE curve is flatter than the LM curve.  At point B, the economy is experiencing:
A)a decreasing money supply.
B)a surplus in the overall balance of payments.
C)an overall balance of payments that is in equilibrium.
D)a high rate of unemployment.

Accepted Answer

At point B, the LM curve has shifted to the left, indicating a decrease in the money supply. The FE curve has also shifted leftward, indicating a surplus in the overall balance of payments. The intersection of the two curves is at a point where the FE curve is steeper than the LM curve, indicating that the economy is in a state of disequilibrium, or excess demand for foreign currency. Therefore, the correct answer is B, a surplus in the overall balance of payments.

Question 8

According to the assignment rule, which of the following policy mixes is appropriate for a country with high inflation, a balance of payments surplus, and fixed exchange rates?
A)Contractionary fiscal policy and contractionary monetary policy
B)Contractionary fiscal policy and expansionary monetary policy
C)Expansionary fiscal policy and expansionary monetary policy
D)Expansionary fiscal policy and contractionary monetary policy

Accepted Answer

Contractionary fiscal policy reduces inflation by decreasing aggregate demand, while expansionary monetary policy can help offset the negative impact on output and employment, maintaining the fixed exchange rate by attracting capital inflows to balance the payments surplus.

Question 9

Under perfect capital mobility and fixed exchange rates, expansionary _____ is especially effective because the _____.
A)fiscal policy; LM curve effectively is vertical.
B)monetary policy; LM curve effectively is the same as the FE curve.
C)fiscal policy; interest rate does not change.
D)monetary policy; interest rate does not change.

Accepted Answer

Under perfect capital mobility and fixed exchange rates, expansionary fiscal policy is especially effective because the interest rate does not change. This is because any potential upward pressure on interest rates from fiscal expansion is offset by capital inflows, which are attracted by the fixed exchange rate, thus keeping the interest rate stable.

Question 10

According to the assignment rule, which of the following policy mixes is appropriate for a country with high unemployment, a balance of payments surplus, and fixed exchange rates?
A)Expansionary fiscal policy and expansionary monetary policy
B)Expansionary fiscal policy and contractionary monetary policy
C)Contractionary fiscal policy and expansionary monetary policy
D)Contractionary fiscal policy and contractionary monetary policy

Accepted Answer

The answer of According to the assignment rule, which of...

Question 11

International capital-flow shocks to an economy with fixed exchange rates necessitates:
A)an offsetting fiscal policy.
B)devaluation or revaluation of the domestic currency.
C)international borrowing by the domestic government.
D)intervention in the foreign exchange market by the domestic monetary authorities.

Accepted Answer

In a fixed exchange rate system, the domestic monetary authorities intervene in the foreign exchange market to maintain the currency's value against another currency or a basket of currencies.

Question 12

Assume that the FE curve is flatter than the LM curve. A negative internal shock shifts the IS curve leftward. Under zero sterilization, which one of the following will happen next?
A)Because of the incipient balance of payments deficit, the LM curve will shift leftward
B)Because of the incipient balance of payments surplus, the LM curve will shift rightward
C)Because of the incipient balance of payments deficit, the IS curve will shift leftward
D)Because of the incipient balance of payments surplus, the IS curve will shift rightward

Accepted Answer

When a negative internal shock shifts the IS curve leftward, it leads to a decrease in income and interest rates, causing a balance of payments deficit. Under zero sterilization, the central bank does not intervene to offset the effects of this deficit on the money supply. Consequently, the money supply decreases, leading to an upward shift in the LM curve, which is represented as a leftward shift in the context of the IS-LM model.

Question 13

Which of the following statements is accurate?
A)Fiscal policy is not effective with fixed exchange rates in an environment of highly responsive international capital flows.
B)Fiscal policy is highly effective with fixed exchange rates and unresponsive international capital flows.
C)Fixed exchange rates greatly constrain a country's ability to pursue an independent monetary policy.
D)Contractionary monetary policy is effective under a fixed exchange rate regime.

Accepted Answer

Fixed exchange rates limit a country's ability to adjust their own monetary policy as they must maintain a certain exchange rate peg. This makes it difficult to pursue an independent monetary policy as adjustments in interest rates may conflict with the fixed exchange rate.

Question 14

The J curve shows that:
A)devaluation is more likely to improve the trade balance in the short-run than in the long-run.
B)devaluation is more likely to improve the trade balance after a longer span of time has elapsed.
C)devaluation is likely to be unstable.
D)devaluation is unlikely to improve the trade balance in either the short-run or the long-run.

Accepted Answer

The J curve theory suggests that following a devaluation, a country's trade balance will initially deteriorate before it starts to improve over time. This is because prices of imports become more expensive immediately, while the volume of exports increases only after a delay, as foreign buyers respond to lower prices.

Question 15

If a country with high unemployment, a balance of payments deficit, and fixed exchange rates decides to abandon it fixed exchange rate and allow its exchange rate to float, which among the following will be a probable effect?
A)Its currency will depreciate, increasing international competitiveness and leading to higher aggregate demand and an improvement in the current account.
B)Its currency will appreciate, increasing international competitiveness and leading to higher aggregate demand and an improvement in the current account.
C)Its currency will depreciate, decreasing international competitiveness and leading to lower aggregate demand and an improvement in the current account.
D)Its currency will appreciate, decreasing international competitiveness and leading to lower aggregate demand and a worsening of the current account.

Accepted Answer

By allowing its exchange rate to float, the country's currency will likely depreciate. This depreciation will increase the international competitiveness of the country's goods and services, leading to higher aggregate demand and an improvement in the current account. This is because foreign buyers will be able to purchase more of the country's goods and services for the same amount of their own currency, making them more enticing. A weaker currency also makes domestic goods cheaper for domestic consumers, leading to increased domestic demand for those goods, which also raises aggregate demand.

Question 16

The figure below shows an IS-LM-FE model for an economy with fixed exchange rates. Initially the economy was at point A, a triple intersection. Here, the FE curve is flatter than the LM curve.  Assume that the economy was initially at point A. Which of the following would have moved the economy to point B?
A)Expansionary monetary policy with sterilization
B)Expansionary monetary policy without sterilization
C)Expansionary fiscal policy with sterilization
D)Contractionary fiscal policy without sterilization

Accepted Answer

The answer of The figure below shows an IS-LM-FE model...

Question 17

According to the assignment rule, which of the following policy mixes is appropriate for a country with high inflation, a balance of payments deficit, and fixed exchange rates?
A)Expansionary fiscal policy and expansionary monetary policy
B)Expansionary fiscal policy and contractionary monetary policy
C)Contractionary fiscal policy and expansionary monetary policy
D)Contractionary fiscal policy and contractionary monetary policy

Accepted Answer

For a country experiencing high inflation and a balance of payments deficit under a fixed exchange rate system, the appropriate policy mix would be contractionary fiscal policy and contractionary monetary policy. Contractionary policies help reduce inflation by decreasing spending and investment, and they can also help improve the balance of payments by reducing imports.

Question 18

Assume that the FE curve is flatter than the LM curve. A negative external capital-flow shock shifts the FE curve left. Under zero sterilization, which one of the following will happen next?
A)Because of the incipient balance of payments deficit, LM curve will shift leftward
B)Because of the incipient balance of payments surplus, LM curve will shift rightward
C)Because of the incipient balance of payments deficit, IS curve will shift rightward
D)Because of the incipient balance of payments surplus, IS curve will shift leftward

Accepted Answer

A negative external capital-flow shock shifts the FE curve left, which increases the demand for domestic currency and leads to an incipient balance of payments deficit. Under zero sterilization, the money supply will stay the same, so there will be excess demand for money in the money market. As a result, interest rates will increase and the LM curve will shift left.

Question 19

Internal shocks to an economy with a fixed exchange rate will:
A)have the same types of impacts as monetary and fiscal policy changes.
B)have no impact on the domestic economy but will lead to external imbalances.
C)have no impact on both the country's internal balance and the country's balance of payments.
D)have no impact on the country's internal balance but will change the country's balance of payments.

Accepted Answer

The answer of Internal shocks to an economy with a...

Question 20

International trade shocks:
A)have no impact on the countries under fixed exchange rate regimes.
B)are of equal concern to large industrialized countries and to developing countries that rely on exporting a few primary commodities.
C)include changes in a country's total exports that result from changes in foreign consumer tastes.
D)are magnified by the use of tariffs and non-tariff barriers.

Accepted Answer

International trade shocks can indeed include changes in a country's total exports that result from changes in foreign consumer tastes, affecting the demand for its goods and services on the global market.

Quiz 23: Internal and External Balance With Fixed Exchange Rates

The combination of currency and bank deposits at the central bank is called the money supply.

The figure below shows an IS-LM-FE model for an economy with fixed exchange rates. Initially the economy was at point A, a triple intersection. Here, the FE curve is flatter than the LM curve. If monetary authorities are unable to sterilize, the interest rate will end up:

Assume that the exchange rates are fixed. When money demand is less sensitive to interest rate changes than are international capital flows, _ policy will be _ effective than when money demand is more sensitive to interest changes than are international capital flows.

Under perfect capital mobility and fixed exchange rates, expansionary _ is a futile attempt because the _.

The figure below shows an IS-LM-FE model for an economy with fixed exchange rates. Initially the economy was at point A, a triple intersection. Here, the FE curve is flatter than the LM curve. In order to maintain the fixed exchange rate, at point B monetary authorities must:

According to the assignment rule, which of the following policy mixes is appropriate for a country with high unemployment, a balance of payments deficit, and fixed exchange rates?

The figure below shows an IS-LM-FE model for an economy with fixed exchange rates. Initially the economy was at point A, a triple intersection. Here, the FE curve is flatter than the LM curve. At point B, the economy is experiencing:

According to the assignment rule, which of the following policy mixes is appropriate for a country with high inflation, a balance of payments surplus, and fixed exchange rates?

Under perfect capital mobility and fixed exchange rates, expansionary _ is especially effective because the _.

According to the assignment rule, which of the following policy mixes is appropriate for a country with high unemployment, a balance of payments surplus, and fixed exchange rates?

International capital-flow shocks to an economy with fixed exchange rates necessitates:

Assume that the FE curve is flatter than the LM curve. A negative internal shock shifts the IS curve leftward. Under zero sterilization, which one of the following will happen next?

Which of the following statements is accurate?

The J curve shows that:

If a country with high unemployment, a balance of payments deficit, and fixed exchange rates decides to abandon it fixed exchange rate and allow its exchange rate to float, which among the following will be a probable effect?

According to the assignment rule, which of the following policy mixes is appropriate for a country with high inflation, a balance of payments deficit, and fixed exchange rates?

Assume that the FE curve is flatter than the LM curve. A negative external capital-flow shock shifts the FE curve left. Under zero sterilization, which one of the following will happen next?

Internal shocks to an economy with a fixed exchange rate will:

International trade shocks: