Question 1

Exhibit: Shifting IS* and LM* A small open economy with a floating exchange rate is initially in equilibrium at A with Holding all else constant, if domestic consumers develop greater preferences for imported goods, then the _____ curve will shift to _____. A)LM₁*; LM₂* B)LM₁*; LM₃* C)IS₁*; IS₂* D)IS₁*; IS₃*

Accepted Answer

The answer of Exhibit: Shifting IS* and LM*  A...

Question 2

To maintain a fixed-exchange-rate system, if the exchange rate (foreign currency/local currency) moves below the fixed-exchange-rate level, then the central bank must:
A)buy foreign currency.
B)sell foreign currency from reserves.
C)raise taxes.
D)decrease government spending.

Accepted Answer

The answer of To maintain a fixed-exchange-rate system, if the...

Question 3

In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to increase the money supply lead the exchange rate to fall, giving arbitrageurs the incentive to _____ the central bank, which causes the money supply to _____.
A)sell domestic currency to; increase
B)sell domestic currency to; decrease
C)buy domestic currency from; increase
D)buy domestic currency from; decrease

Accepted Answer

In the Mundell-Fleming model with fixed exchange rates, increasing the money supply leads to a decrease in the exchange rate. This makes domestic goods cheaper and imports more expensive, leading to a balance of payments surplus. Arbitrageurs will take advantage of this by selling domestic currency, causing its value to decrease further. In response, the central bank will have to sell its foreign exchange reserves to maintain the fixed exchange rate, leading to a decrease in the money supply. Therefore, attempts to increase the money supply will ultimately lead to a decrease.

Question 4

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the new short-run equilibrium:
A)the exchange rate rises, but income does not rise.
B)income rises, but the exchange rate does not rise.
C)both income and the exchange rate rise.
D)neither income nor the exchange rate rises, as the money supply contracts.

Accepted Answer

In a small open economy with a fixed exchange rate, an increase in government purchases shifts the aggregate demand curve to the right, leading to an increase in equilibrium output (income) in the short run. However, the fixed exchange rate means that the central bank must intervene in the foreign exchange market to ensure the exchange rate remains constant. To do this, the central bank must increase the money supply, which leads to an increase in investment and consumption, further increasing output. But, since the increase in the money supply leads to a decrease in interest rates, capital outflows increase, causing the exchange rate to depreciate as foreign investors sell domestic assets, and domestic residents buy foreign assets. Thus, income rises, but the exchange rate does not rise.

Question 5

During the Great Depression, countries that devalued their currencies generally _____, whereas countries that maintained the old exchange rate _____.
A)suffered longer; experienced no depression
B)recovered relatively quickly; experienced no depression
C)suffered longer; recovered relatively quickly
D)recovered relatively quickly; suffered longer

Accepted Answer

Countries that devalued their currencies were able to make their exports cheaper and more competitive, leading to increased demand and economic growth. On the other hand, countries that maintained the old exchange rate found it difficult to compete in the global market, leading to longer periods of economic suffering.

Question 6

Exhibit: IS*-LM* A small open economy with a fixed exchange rate e₂ is initially at equilibrium A with IS₁*, LM₁* and equilibrium output Y₁. If there is a monetary expansion, the new equilibrium will be at _____, holding everything else constant. A)A B)B C)C D)D

Accepted Answer

The answer of Exhibit: IS*-LM*  A small open economy...

Question 7

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

Accepted Answer

Under a fixed system, the exchange rate is maintained at a predetermined level by the central bank. This means that the central bank will intervene in the foreign exchange market to buy or sell its own currency in order to keep the exchange rate within a specified range. This is done to promote stability and predictability in the exchange rate, which can be important for trade and investment decisions.

Question 8

If the Bank of Canada announces that it will fix the exchange rate at 100 yen per Canadian dollar, but with the current money supply the equilibrium exchange rate is 150 yen per dollar, then:
A)arbitrageurs will sell yen in the marketplace.
B)arbitrageurs will buy yen from the Bank of Canada.
C)the money supply will fall until the market exchange rate is 100 yen per dollar.
D)the money supply will rise until the market exchange rate is 100 yen per dollar.

Accepted Answer

The answer of If the Bank of Canada announces that...

Question 9

A revaluation of a currency under a fixed-exchange-rate system occurs when the level at which the currency is fixed is:
A)increased.
B)decreased.
C)allowed to float.
D)kept fixed within a band.

Accepted Answer

A revaluation occurs when a country's central bank decides to increase the value of its currency against another currency or a basket of currencies. This is typically done under a fixed-exchange-rate system to address a trade imbalance, attract foreign investment or reduce inflation. A decrease in the level at which the currency is fixed is called a devaluation. Allowing the currency to float or keeping it fixed within a band are different exchange rate regimes that do not involve a revaluation or devaluation.

Question 10

In a small open economy with a fixed exchange rate, if the country devalues its currency, then in the new short-run equilibrium the exchange rate _____, and the LM* curve shifts to the _____.
A)decreases; left
B)increases; left
C)decreases; right
D)increases; right

Accepted Answer

If the country devalues its currency, then the exchange rate decreases (since it takes fewer units of domestic currency to buy foreign currency), and the LM* curve shifts to the right (since the lower exchange rate increases net exports, leading to an increase in real money demand and a higher interest rate).

Question 11

If there is a fixed-exchange-rate system, then in the long run:
A)the nominal exchange rate is fixed, but the real exchange rate is free to vary.
B)the real exchange rate is fixed, but the nominal exchange rate is free to vary.
C)both the nominal and real exchange rates are fixed.
D)the nominal and real exchange rates vary by a fixed amount.

Accepted Answer

In a fixed-exchange-rate system, the nominal exchange rate is set by the government or central bank and does not change, or changes only within very narrow boundaries. However, the real exchange rate, which adjusts the nominal rate by the relative price levels between countries, can vary due to changes in inflation rates, productivity, and other economic factors.

Question 12

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

Accepted Answer

The answer of Exhibit: IS*-LM*  A small open economy...

Question 13

In a small open economy with a floating exchange rate, if the government imposes an import quota, then in the new short-run equilibrium the IS^* curve shifts to the right, raising the exchange rate: A)but not raising net exports or income. B)and net exports but not income. C)and income but not net exports. D)net exports and income.

Accepted Answer

In a small open economy with a floating exchange rate, imposing an import quota initially reduces imports, which could increase demand for domestic goods. However, the exchange rate would adjust (appreciate) to offset this, making exports more expensive and imports cheaper again, thus neutralizing the effect on net exports and income. The adjustment in the exchange rate does not lead to an increase in net exports or income in the short run.

Question 14

If there is a fixed-exchange-rate system, then in the short run described by the Mundell-Fleming model:
A)the nominal exchange rate is fixed, but the real exchange rate is free to vary.
B)the real exchange rate is fixed, but the nominal exchange rate is free to vary.
C)both the nominal and real exchange rates are fixed.
D)the nominal exchange rate is fixed, but whether the real exchange rate is fixed depends on whether the central bank follows a rule of constant growth of the money supply.

Accepted Answer

The answer of If there is a fixed-exchange-rate system, then...

Question 15

In a small open economy with a fixed exchange rate, if the government imposes an import quota, then net exports:
A)decrease, but the money supply falls and income falls.
B)increase, the money supply increases, and income increases.
C)are unchanged, but the money supply falls and income falls.
D)are unchanged, the money supply is unchanged, and income is unchanged.

Accepted Answer

Imposing an import quota in a small open economy with a fixed exchange rate reduces imports, which increases net exports. As net exports increase, the money supply in the economy also increases because the central bank must buy foreign currency to maintain the fixed exchange rate, injecting more domestic currency into the economy. This increase in the money supply boosts aggregate demand, leading to an increase in income.

Question 16

Exhibit: Shifting IS* and LM* A small open economy with a floating exchange rate is initially in equilibrium at A with Holding all else constant, if the government imposes a tariff on imports in order to protect domestic jobs, then the _____ curve will shift to _____. A)LM₁*; LM₂* B)LM₁*; LM₃* C)IS₁*; IS₂* D)IS₁*; IS₃*

Accepted Answer

The answer of Exhibit: Shifting IS* and LM*  A...

Question 17

According to the Mundell-Fleming model for a small open economy with flexible exchange rates, if the Bank of Canada cannot alter domestic interest rates, changes in the money supply could still influence aggregate income through changes in the:
A)exchange rate.
B)price level.
C)level of government spending.
D)tax rates.

Accepted Answer

In a small open economy with flexible exchange rates, changes in the money supply affect the exchange rate, which in turn influences net exports and aggregate income.

Question 18

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the process of adjusting to the new short-run equilibrium, the money supply:
A)increases to keep the exchange rate unchanged, thus augmenting the effect of government spending on income.
B)decreases to keep the exchange rate unchanged, thus offsetting the effect of government spending on income.
C)remains unchanged, and there is no effect of government spending on income.
D)remains unchanged to keep the interest rate at the world interest rate, so that government spending reduces income.

Accepted Answer

In a small open economy, a fixed exchange rate implies that the central bank will maintain the exchange rate by buying or selling domestic currency in the foreign exchange market. If the government increases government purchases, it will increase aggregate demand in the economy, leading to a short-run increase in output and prices. To maintain the fixed exchange rate, the central bank will purchase domestic currency in exchange for foreign currency, increasing the money supply. This increase in the money supply will further augment the effect of government spending on income. Therefore, the correct choice is A.

Question 19

In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium:
A)imports will decrease while exports remain constant, leading to a rise in net exports.
B)imports will decrease and exports will increase, leading to a rise in net exports.
C)imports will decrease and exports will decrease by an equal amount.
D)both imports and exports will remain unchanged.

Accepted Answer

The answer of In a small open economy with a...

Question 20

Under a fixed-exchange-rate system, the central bank of a small open economy must:
A)have a reserve of its own currency, which it must have accumulated in past transactions.
B)have a reserve of foreign currency, which it can print.
C)allow the money supply to adjust to whatever level will ensure that the equilibrium exchange rate equals the announced exchange rate.
D)follow a rule specifying a constant growth rate for the money supply.

Accepted Answer

Under a fixed-exchange-rate system, the central bank must ensure that the equilibrium exchange rate matches the announced exchange rate. This can be achieved by adjusting the money supply to the appropriate level. The other options are not accurate as the central bank cannot print foreign currency (B) and does not need to have a reserve of its own currency accumulated from past transactions (A). Following a constant growth rate rule for the money supply (D) is not necessary under a fixed-exchange-rate system.

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

Exhibit: Shifting IS* and LM* A small open economy with a floating exchange rate is initially in equilibrium at A with Holding all else constant, if domestic consumers develop greater preferences for imported goods, then the _ curve will shift to _.

To maintain a fixed-exchange-rate system, if the exchange rate (foreign currency/local currency) moves below the fixed-exchange-rate level, then the central bank must:

In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to increase the money supply lead the exchange rate to fall, giving arbitrageurs the incentive to _ the central bank, which causes the money supply to _.

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the new short-run equilibrium:

During the Great Depression, countries that devalued their currencies generally _, whereas countries that maintained the old exchange rate _.

Exhibit: IS-LM A small open economy with a fixed exchange rate e₂ is initially at equilibrium A with IS₁, LM₁ and equilibrium output Y₁. If there is a monetary expansion, the new equilibrium will be at _____, holding everything else constant.

Under a fixed system, the exchange rate:

If the Bank of Canada announces that it will fix the exchange rate at 100 yen per Canadian dollar, but with the current money supply the equilibrium exchange rate is 150 yen per dollar, then:

A revaluation of a currency under a fixed-exchange-rate system occurs when the level at which the currency is fixed is:

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

If there is a fixed-exchange-rate system, then in the long run:

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

In a small open economy with a floating exchange rate, if the government imposes an import quota, then in the new short-run equilibrium the IS^* curve shifts to the right, raising the exchange rate:

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

In a small open economy with a fixed exchange rate, if the government imposes an import quota, then net exports:

Exhibit: Shifting IS* and LM* A small open economy with a floating exchange rate is initially in equilibrium at A with Holding all else constant, if the government imposes a tariff on imports in order to protect domestic jobs, then the _ curve will shift to _.

According to the Mundell-Fleming model for a small open economy with flexible exchange rates, if the Bank of Canada cannot alter domestic interest rates, changes in the money supply could still influence aggregate income through changes in the:

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the process of adjusting to the new short-run equilibrium, the money supply:

In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium:

Under a fixed-exchange-rate system, the central bank of a small open economy must: