Question 1

If the exchange rate of currency A is fixed to a unit of currency B, then a potential problem for the central bank in charge of currency A is:

Accepted Answer

When a central bank fixes its currency (A) to another currency (B), it must maintain reserves of currency B to manage its exchange rate. If there's high demand for currency B or if the central bank needs to support the fixed exchange rate by selling B and buying A, it risks depleting its reserves of currency B.

Question 2

According to the Mundell-Fleming model, import restrictions in an economy with flexible exchange rates cause net exports to _____, and in an economy with fixed exchange rates, import restrictions cause net exports to _____.

Accepted Answer

In an economy with flexible exchange rates, import restrictions will cause the domestic currency to appreciate, making exports more expensive and imports cheaper, leading to a decrease in net exports. However, in an economy with fixed exchange rates, the government will need to intervene to maintain the fixed exchange rate, which may require limiting foreign exchange reserves and increasing interest rates, leading to a decrease in domestic demand and a decrease in net imports, thereby increasing net exports. Therefore, import restrictions in an economy with fixed exchange rates cause net exports to remain unchanged or increase.

Question 3

Exhibit: Risk Premium A small open economy with a floating exchange rate is initially in equilibrium at A with IS₁*; LM₁*. If there is an increase in the risk premium, then LM₁* will shift to _____ and IS₁* will shift to _____.

Accepted Answer

The answer of Exhibit: Risk Premium  A small open...

Question 4

Country risk included in the risk premium in interest rates refers to the:

Accepted Answer

Country risk refers to the possibility that loans in some countries may not be repaid because of political upheaval, economic instability, or other factors. This risk is included in the risk premium in interest rates to compensate lenders for the additional risk they are taking on by lending in these countries.

Question 5

A monetary union with a common currency is an example of a:

Accepted Answer

A monetary union with a common currency implies that the exchange rate between the member countries is fixed, as they all use the same currency. Therefore, this is an example of a fixed-exchange-rate system.

Question 6

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes the exchange rate to _____, and expansionary monetary policy causes the exchange rate to _____.

Accepted Answer

According to the Mundell-Fleming model, expansionary fiscal policy causes an increase in income, which leads to an increase in demand for imports, leading to an increase in demand for foreign currency, which causes the exchange rate to rise. On the other hand, expansionary monetary policy causes a decrease in interest rates, which leads to capital outflows, causing a decrease in demand for the home currency and an increase in supply, leading to a decrease in the exchange rate. Therefore, expansionary fiscal policy causes the exchange rate to rise and expansionary monetary policy causes the exchange rate to fall.

Question 7

Some economists argue that monetary union does not work as well in Europe as it does in Canada and the United States for all of the following reasons except:

Accepted Answer

The European Central Bank (ECB) does exist and is responsible for monetary policy in the Eurozone, similar to central banks in Canada and the United States.

Question 8

One argument favouring a fixed-exchange-rate system is that it:

Accepted Answer

A fixed-exchange-rate system reduces exchange-rate uncertainty, which can promote more international trade by providing stability and predictability in international transactions.

Question 9

According to the Mundell-Fleming model, under flexible exchange rates, expansionary monetary policy _____ increase income, and under fixed exchange rates, expansionary monetary policy _____ increase income.

Accepted Answer

Under flexible exchange rates, an expansionary monetary policy will lead to an increase in the domestic interest rate which, in turn, will cause capital inflows, an appreciation of the domestic currency, and a decrease in net exports. This decrease in net exports will partially offset the initial increase in income. Therefore, the increase in income is less than it would have been in the absence of the exchange rate response. 
Under fixed exchange rates, an expansionary monetary policy will cause an increase in the money supply, which will in turn drive down the interest rate.These lower interest rates would reduce the demand for the domestic currency, and increase the demand for foreign currencies, driving down the exchange rate. Therefore, the increase in income would be offset by the decrease in net exports due to the adverse effect on the exchange rate.

Question 10

A speculative attack on a currency occurs when:

Accepted Answer

A speculative attack on a currency occurs when investors lose confidence in the value of the currency, causing them to sell off their holdings and thereby driving down the exchange rate. This can be triggered by a variety of factors, but one common cause is a shift in perceptions about the country's economic and financial stability. In such cases, a fixed exchange rate regime may be particularly vulnerable, as investors may view it as unsustainable and seek to take advantage of any perceived weakness in the system. The other options listed (A, C, and D) all involve changes to a country's exchange rate regime, but do not necessarily imply anything about the stability of the currency or the likelihood of a speculative attack.

Question 11

According to the Mundell-Fleming model, under:

Accepted Answer

The Mundell-Fleming model suggests that under floating exchange rates, a monetary expansion increases income because it can affect the exchange rate and thus impact net exports positively. However, a fiscal expansion has little effect on income because it leads to an appreciation of the currency, which can offset the initial stimulus. Under fixed exchange rates, the opposite is true: a fiscal expansion can raise income because the exchange rate cannot adjust to offset the fiscal stimulus, while a monetary expansion has little effect on income since the central bank must intervene in the forex market to maintain the fixed exchange rate, neutralizing the monetary expansion's impact on income.

Question 12

The risk premium included in the interest rate of small open economies incorporates:

Accepted Answer

The risk premium included in the interest rate of small open economies incorporates country risk due to economic and political conditions, as well as expectations of future exchange-rate changes.

Question 13

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) _____ sufficient to offset the decline in the demand for money caused by the higher risk premium.

Accepted Answer

The answer of An increase in income generated by an...

Question 14

"Crony capitalism" refers to situations in which banks make loans to those borrowers with the most:

Accepted Answer

Crony capitalism refers to situations where banks prioritize loans to borrowers with political connections, rather than making loans based on profitability or creditworthiness.

Question 15

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) _____ sufficient to offset the decline in the demand for money caused by the higher risk premium.

Accepted Answer

The answer of An increase in income generated by an...

Question 16

In the Mundell-Fleming model with fixed exchange rates, the imposition of trade restrictions results in an increase in net exports because:

Accepted Answer

The answer of In the Mundell-Fleming model with fixed exchange...

Question 17

In order to compensate for an expected future decline in the Japanese yen relative to the dollar, the interest rate in Japan must be _____ the interest rate in Canada.

Accepted Answer

If the Japanese yen is expected to decline relative to the dollar, then Japanese investors will demand a higher interest rate to compensate for the expected loss in the value of their investments.

Question 18

In the Mundell-Fleming model, expectations that a currency will lose value in the future will cause the current exchange rate to:

Accepted Answer

If individuals expect that a currency will lose value in the future (i.e. depreciate), then they will want to sell that currency now in order to avoid the potential loss. This increased supply of the currency on the foreign exchange market will cause the exchange rate to decrease in the present.

Question 19

One argument favouring a floating-exchange-rate system is that it:

Accepted Answer

A floating-exchange-rate system allows a country to use its monetary policy for domestic objectives, such as controlling inflation or stimulating growth, without having to maintain a fixed exchange rate.

Question 20

According to the Mundell-Fleming model, under fixed exchange rates, expansionary fiscal policy causes income to _____, and under flexible exchange rates expansionary fiscal policy causes income to _____.

Accepted Answer

The answer of According to the Mundell-Fleming model, under fixed...

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

If the exchange rate of currency A is fixed to a unit of currency B, then a potential problem for the central bank in charge of currency A is:

According to the Mundell-Fleming model, import restrictions in an economy with flexible exchange rates cause net exports to _, and in an economy with fixed exchange rates, import restrictions cause net exports to _.

Exhibit: Risk Premium A small open economy with a floating exchange rate is initially in equilibrium at A with IS₁; LM₁. If there is an increase in the risk premium, then LM₁* will shift to _ and IS₁* will shift to _.

Country risk included in the risk premium in interest rates refers to the:

A monetary union with a common currency is an example of a:

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes the exchange rate to _, and expansionary monetary policy causes the exchange rate to _.

Some economists argue that monetary union does not work as well in Europe as it does in Canada and the United States for all of the following reasons except:

One argument favouring a fixed-exchange-rate system is that it:

According to the Mundell-Fleming model, under flexible exchange rates, expansionary monetary policy _ increase income, and under fixed exchange rates, expansionary monetary policy _ increase income.

A speculative attack on a currency occurs when:

According to the Mundell-Fleming model, under:

The risk premium included in the interest rate of small open economies incorporates:

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) _____ sufficient to offset the decline in the demand for money caused by the higher risk premium.

"Crony capitalism" refers to situations in which banks make loans to those borrowers with the most:

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) _____ sufficient to offset the decline in the demand for money caused by the higher risk premium.

In the Mundell-Fleming model with fixed exchange rates, the imposition of trade restrictions results in an increase in net exports because:

In order to compensate for an expected future decline in the Japanese yen relative to the dollar, the interest rate in Japan must be _____ the interest rate in Canada.

In the Mundell-Fleming model, expectations that a currency will lose value in the future will cause the current exchange rate to:

One argument favouring a floating-exchange-rate system is that it:

According to the Mundell-Fleming model, under fixed exchange rates, expansionary fiscal policy causes income to _, and under flexible exchange rates expansionary fiscal policy causes income to _.

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

If the exchange rate of currency A is fixed to a unit of currency B, then a potential problem for the central bank in charge of currency A is:

According to the Mundell-Fleming model, import restrictions in an economy with flexible exchange rates cause net exports to _____, and in an economy with fixed exchange rates, import restrictions cause net exports to _____.

Exhibit: Risk Premium A small open economy with a floating exchange rate is initially in equilibrium at A with IS1*; LM1*. If there is an increase in the risk premium, then LM1* will shift to _____ and IS1* will shift to _____.

Country risk included in the risk premium in interest rates refers to the:

A monetary union with a common currency is an example of a:

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes the exchange rate to _____, and expansionary monetary policy causes the exchange rate to _____.

Some economists argue that monetary union does not work as well in Europe as it does in Canada and the United States for all of the following reasons except:

One argument favouring a fixed-exchange-rate system is that it:

According to the Mundell-Fleming model, under flexible exchange rates, expansionary monetary policy _____ increase income, and under fixed exchange rates, expansionary monetary policy _____ increase income.

A speculative attack on a currency occurs when:

According to the Mundell-Fleming model, under:

The risk premium included in the interest rate of small open economies incorporates:

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) _____ sufficient to offset the decline in the demand for money caused by the higher risk premium.

"Crony capitalism" refers to situations in which banks make loans to those borrowers with the most:

An increase in income generated by an increase in the country risk premium will not occur if there is a(n) _____ sufficient to offset the decline in the demand for money caused by the higher risk premium.

In the Mundell-Fleming model with fixed exchange rates, the imposition of trade restrictions results in an increase in net exports because:

In order to compensate for an expected future decline in the Japanese yen relative to the dollar, the interest rate in Japan must be _____ the interest rate in Canada.

In the Mundell-Fleming model, expectations that a currency will lose value in the future will cause the current exchange rate to:

One argument favouring a floating-exchange-rate system is that it:

According to the Mundell-Fleming model, under fixed exchange rates, expansionary fiscal policy causes income to _____, and under flexible exchange rates expansionary fiscal policy causes income to _____.

According to the Mundell-Fleming model, import restrictions in an economy with flexible exchange rates cause net exports to _, and in an economy with fixed exchange rates, import restrictions cause net exports to _.

Exhibit: Risk Premium A small open economy with a floating exchange rate is initially in equilibrium at A with IS₁; LM₁. If there is an increase in the risk premium, then LM₁* will shift to _ and IS₁* will shift to _.

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes the exchange rate to _, and expansionary monetary policy causes the exchange rate to _.

According to the Mundell-Fleming model, under flexible exchange rates, expansionary monetary policy _ increase income, and under fixed exchange rates, expansionary monetary policy _ increase income.

According to the Mundell-Fleming model, under fixed exchange rates, expansionary fiscal policy causes income to _, and under flexible exchange rates expansionary fiscal policy causes income to _.