Question 1

Using indirect intervention, the Fed attempts to affect the dollar's value indirectly by influencing the factors that determine it, such as interest rates.

Accepted Answer

The Fed uses indirect intervention to influence the dollar's value by affecting the factors that determine it, such as interest rates. This includes actions like adjusting the federal funds rate or conducting open market operations.

Question 2

Among the reasons for government intervention are:

Accepted Answer

All of the above reasons are valid reasons for government intervention in the foreign exchange market. Government intervention can help to stabilize exchange rates, prevent exchange rate volatility, and respond to temporary disturbances such as sudden capital flows or geopolitical events. Establishing implicit exchange rate boundaries can also help to support economic growth and stability in the long run, by ensuring that exchange rates remain within a certain range that is supportive of sustainable economic growth.

Question 3

In order to stimulate a stagnant economy, a government operating under a managed float may attempt to weaken its currency.

Accepted Answer

When a government operating under a managed float weakens its currency, it makes its exports cheaper and more attractive to foreign buyers, thereby boosting demand for its goods and services and potentially stimulating economic growth.

Question 4

While a strong currency is a possible cure for high inflation, it may cause higher unemployment due to the attractive foreign prices that result from a strong home currency.

Accepted Answer

A strong currency can make exports more expensive and imports cheaper, leading to higher unemployment as domestic producers struggle to compete with foreign products. This is known as the "Dutch disease" effect.

Question 5

Assume that the dollar has been consistently depreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using sterilized intervention. The Fed would

Accepted Answer

Sterilized intervention involves the central bank buying or selling its own currency on the foreign exchange market while simultaneously engaging in offsetting transactions in the domestic bond market to neutralize the impact on the domestic money supply. In this case, to counteract the dollar's depreciation, the Fed would buy dollars with foreign currency to increase the value of the dollar. To sterilize this intervention and prevent an increase in the money supply (which could potentially counteract the intended strengthening of the dollar), the Fed would also buy Treasury securities with dollars, removing those dollars from circulation.

Question 6

An advantage of a fixed exchange rate system is that governments are not required to constantly intervene in the foreign exchange market to maintain exchange rates within specified boundaries.

Accepted Answer

In a fixed exchange rate system, governments do need to intervene in the foreign exchange market to maintain exchange rates within specified boundaries. This can involve using their own reserves to buy or sell their currency in order to keep it at the desired rate.

Question 7

Which of the following is true regarding the euro?

Accepted Answer

A) Exchange rate risk between participating European currencies is eliminated as they all use the same currency, making trade and capital flows across European borders easier.
B) With the same currency, there is more consistency in economic conditions across countries.
C) As each country gives up control over its own currency, they also give up their ability to conduct their own monetary policy.

Question 8

Assume the Fed desires to strengthen the dollar. If it buys dollars and simultaneously buys Treasury securities, this is an example of sterilized intervention.

Accepted Answer

Sterilized intervention is when the central bank buys or sells its own currency in the foreign exchange market while simultaneously undertaking an offsetting transaction in the domestic money market (such as buying or selling government securities) in order to neutralize the impact of the intervention on the domestic money supply. In this case, the Fed is buying dollars and buying Treasury securities to prevent the increase in the money supply and sterilize the impact of its intervention on domestic inflation and interest rates.

Question 9

Countries usually do not have difficulty maintaining a pegged exchange rate, even when they are experiencing major political or economic problems.

Accepted Answer

Countries can face difficulties maintaining a pegged exchange rate during times of political or economic turmoil. This is because maintaining a peg requires a stable and consistent monetary policy, which may be harder to achieve in times of instability. Additionally, external shocks or changes in global economic conditions can make it difficult to maintain a peg, as seen in the Asian financial crisis of the late 1990s.

Question 10

Assume that the dollar has been consistently appreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using nonsterilized intervention. The Fed would

Accepted Answer

The Fed would buy dollars with foreign currency and simultaneously sell Treasury securities for dollars to counteract the appreciation of the dollar. This would increase the supply of dollars in the foreign exchange market and decrease the demand for dollars, which would lead to a depreciation of the dollar.

Question 11

Which of the following is not true regarding the Mexican peso crisis?

Accepted Answer

Many speculators based in the U.S. speculated on the potential decline in the peso by withdrawing their funds from Mexico, not by investing in Mexico.

Question 12

Under a fixed exchange rate system, U.S. inflation would have a greater impact on inflation in other countries than it would under a freely floating exchange rate system.

Accepted Answer

Under a fixed exchange rate system, the exchange rates between currencies are fixed, which means that any increase in U.S. inflation would increase the prices of U.S. goods, making them more expensive for other countries. This would cause inflation in other countries as they would need to pay more for U.S. goods, leading to an increase in their own prices. On the other hand, under a freely floating exchange rate system, the exchange rates between currencies move in response to market forces, which means that the impact of U.S. inflation on other countries would be muted as their currencies would adjust accordingly.

Question 13

Which of the following is not true regarding government intervention?

Accepted Answer

The statement "Under the direct method of intervention, an appreciation of the dollar would be accomplished by exchanging dollars for foreign currencies" is not true. In fact, under the direct method of intervention, the Fed would buy or sell foreign currencies in order to directly affect the value of the dollar without adjusting the money supply. Therefore, option A is incorrect.

Question 14

Under the system known as the "dirty" float, official boundaries for the exchange rate exist, but they are wider than they are under a fixed exchange rate system.

Accepted Answer

In a "dirty" float system (also known as a managed float), a country's currency exchange rate is generally allowed to fluctuate according to the foreign exchange market, but the central bank can intervene to stabilize or influence the currency's value. There are no official boundaries for the exchange rate like in a fixed exchange rate system.

Question 15

In a freely floating exchange rate system, high U.S. inflation rate may be magnified. This is because the depreciation of the dollar would result in more expensive foreign imports, thus reducing foreign competition.

Accepted Answer

In a freely floating exchange rate system, a high U.S. inflation rate can lead to a depreciation of the dollar, which would increase the prices of foreign imports. This, in turn, could reduce foreign competition and potentially magnify the impact of the inflation rate on the domestic economy.

Question 16

While a weak currency can reduce unemployment at home, it can also lead to higher inflation, as local companies are better able to raise prices.

Accepted Answer

A weak currency makes imports more expensive, which can lead to higher inflation. Additionally, local companies are able to raise prices since their products become relatively cheaper compared to foreign products.

Quiz 6: Government Influence on Exchange Rates