Question 1

Could a country be open to international capital flows, control its domestic interest rate and fix its exchange rate? Explain.

Accepted Answer

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Question 2

While it is true that central banks of many countries intervene in the foreign exchange market, why wouldn't it be correct to say that central banks of these countries fix the exchange rates?

Accepted Answer

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Question 3

Consider the current peso/dollar exchange rate is 100 pesos per dollar and the current inflation rate in Mexico and the U.S. is 3 percent in each country. Assuming purchasing power parity, what will the exchange rate be if the inflation rate increases to 5 percent in Mexico and falls to 2 percent in the U.S.?

Accepted Answer

The answer of Consider the current peso/dollar exchange rate is...

Question 4

The failure of the Argentinean currency board can be attributed to many factors, including the:

Accepted Answer

The failure of the Argentinean currency board can be attributed to pegging the Argentine peso to the U.S. dollar, even though the countries' economies were not that highly integrated. This made Argentina lose its monetary sovereignty and its ability to adjust its currency to its economic needs. As a result, the country experienced a severe economic crisis in 2001.

Question 5

A problem with currency boards is that the central bank loses:

Accepted Answer

Currency boards require a fixed exchange rate between the domestic currency and a reserve currency, which means that the central bank cannot adjust interest rates to achieve monetary policy objectives. This represents a loss of influence over interest rates. While currency boards can help to ensure price stability and fiscal discipline, they may also limit the ability of policymakers to respond to changing economic conditions.

Question 6

Everything else equal, if the Fed decided to fix the euro/dollar exchange rate, what would be the impact on the interest rate in the U.S. if the euro started to appreciate in value and why?

Accepted Answer

The answer of Everything else equal, if the Fed decided...

Question 7

Imagine the exchange rate between the British pound (£) and the U.S. dollar ($) is fixed at
$1.40/£ and capital flows freely between Great Britain and the U.S. Explain what the price of shares of stock in XYZ Inc. would be selling for in London if they are $80 per share in the U.S. and why.

Accepted Answer

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Question 8

Are foreign exchange market interventions the only tool available to a central bank to change the exchange rate? Explain.

Accepted Answer

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Question 9

Dollarization is associated with each of the following, except:

Accepted Answer

Dollarization typically facilitates faster integration into world markets by reducing currency risk and enhancing trade and investment flows with countries using the same currency. The other options (B, C, D) are direct consequences of dollarization.

Question 10

Assuming the free flow of capital, explain why the central bank of a country that has fixed its exchange rate would not find discussions of inflation on the agenda of its policy meetings.

Accepted Answer

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Question 11

The benefits to a country from dollarization include each of the following, except:

Accepted Answer

Dollarization eliminates a country's ability to receive seignorage, which is the revenue gained from printing money. This is because the country will no longer have its own currency to print and instead must use the United States dollar. Therefore, the correct answer is D.

Question 12

Monetary union, in comparison to dollarization, means that:

Accepted Answer

Monetary union involves multiple countries sharing a common currency and central bank, which means that they also share in monetary policy decisions. This is in contrast to dollarization, where a country adopts a foreign currency (such as the US dollar) as its own and gives up control over monetary policy. While countries in a monetary union may forego some revenues from seignorage (the difference between the cost of producing and the face value of currency), they still have a say in the policy decisions affecting their economy. Option C is also incorrect, as the central bank in a monetary union can still function as a lender of last resort. Therefore, option B is the best choice.

Question 13

A lesson that policymakers should learn from the Argentinean experience with currency boards is:

Accepted Answer

The Argentinean experience with a currency board showed that poor fiscal policies can undermine any monetary policy regime, even one as stringent as a currency board. This highlights the importance of maintaining sound fiscal policies alongside a fixed exchange rate system.

Question 14

Using demand and supply analysis, explain why the euro/dollar exchange rate rises (the dollar appreciates) if the Fed intervenes in the foreign exchange market and sells euros.

Accepted Answer

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Question 15

How would the impact on the exchange rate differ if the Fed were to sell U.S. Treasury securities instead of selling an equal amount (in $ terms) of euros?

Accepted Answer

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Question 16

Capital flows freely between two countries and the countries have fixed exchange rates. The treasury bonds of each country have similar maturities but different expected returns. What can you deduce from this information?

Accepted Answer

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Question 17

Which of the following best defines dollarization?

Accepted Answer

Dollarization is when a country adopts a foreign currency (usually the U.S. dollar) as its national currency and uses it exclusively for all transactions, effectively eliminating its own monetary policy. This is different from simply using the U.S. dollar alongside the country's own currency (answer A) or requiring international transactions to be conducted in U.S. dollars (answer C). Answer D describes a fixed exchange rate agreement, which is not necessarily dollarization.

Question 18

What are the cost and benefits to a country instituting capital controls?

Accepted Answer

The answer of What are the cost and benefits to...

Question 19

Everything else equal, if the Fed decided to fix the euro/dollar exchange rate, what would be the impact on the money supply in the U.S. if the euro started to decline in value and why?

Accepted Answer