Question 1

Which of the following statements describes the interest parity condition?
A) In the equilibrium, all the prices must be the same in the international market.
B) In the equilibrium, the inflation rates must be the same in the international market.
C) In the long run, the exchange rates must be the same in the international market.
D) In the equilibrium, the rates of return on assets of comparable risk and liquidity must be the same in the international market.

Accepted Answer

The interest parity condition states that in the equilibrium, the rates of return on assets of comparable risk and liquidity must be the same in the international market. This means that investors should earn the same returns irrespective of where they invest, after accounting for any differences in risk and liquidity. This condition holds true in the long run and is an important concept in international finance.

Question 2

Which of the following changes would cause Canadian net exports to increase?
A) an increase in the real value of the dollar
B) an increase in Canadian income
C) an increase in foreign income
D) a shift in demand by Canadian consumers away from domestically produced goods

Accepted Answer

An increase in foreign income would cause Canadian net exports to increase because foreign consumers would be able to afford more Canadian exports, leading to an increase in demand for Canadian goods and services.

Question 3

A decrease in foreign output would cause the domestic country's net exports to ________ and cause the domestic country's IS curve to ________.
A) rise; shift up
B) rise; shift down
C) fall; shift up
D) fall; shift down

Accepted Answer

A decrease in foreign output would cause a decrease in demand for domestic goods and services, leading to a fall in net exports. This would then lead to a decrease in the equilibrium level of output, causing the IS curve to shift down.

Question 4

A decline in the domestic real interest rate would cause a ________ in net exports and a ________ in the exchange rate.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Accepted Answer

A decline in the domestic real interest rate would lead to an increase in net exports as domestic goods become relatively cheaper for foreigners. It would also lead to a depreciation (fall) in the exchange rate as lower interest rates reduce foreign investment in domestic assets, decreasing demand for the domestic currency.

Question 5

An increase in the Canadian money supply would cause the value of the dollar to ________ and net Canadian exports to ________ in the short run using a Keynesian model.
A) rise; rise
B) fall; rise
C) rise; fall
D) fall; fall

Accepted Answer

The answer of An increase in the Canadian money supply...

Question 6

In a Keynesian model, a temporary decrease in government purchases would cause output to ________ and the domestic real interest rate to ________.
A) not change; increase
B) not change; decrease
C) decrease; increase
D) decrease; decrease

Accepted Answer

The answer of In a Keynesian model, a temporary decrease...

Question 7

The Canadian real interest rate rises relative to the British real interest rate. British net exports ________ and the British exchange rate ________.
A) increase; rises
B) increase; falls
C) decrease; rises
D) decrease; falls

Accepted Answer

The answer of The Canadian real interest rate rises relative...

Question 8

In the short run in the Keynesian model, an increase in the domestic money supply would cause domestic output to ________ and the domestic real interest rate to ________.
A) rise; rise
B) fall; rise
C) rise; fall
D) fall; fall

Accepted Answer

In the short run in the Keynesian model, an increase in the domestic money supply would cause domestic output to rise as households and firms would have more money to spend leading to an increase in aggregate demand. At the same time, the increase in the money supply would lead to a fall in the domestic real interest rate as individuals have more cash to spend, thereby reducing the demand for credit, which leads to a lower interest rate. This fall in the real interest rate would further increase aggregate demand, leading to an increase in domestic output.

Question 9

Goods market equilibrium in the open economy occurs when
A) desired saving equals desired investment.
B) output equals desired consumption plus desired investment plus government spending.
C) desired consumption equals desired investment.
D) desired saving minus desired investment equals net exports.

Accepted Answer

In the open economy, the equilibrium in the goods market occurs when the excess of desired saving over desired investment is exactly equal to the amount of net exports. This can be expressed as S - I = NX, where S represents desired saving, I represents desired investment, and NX represents net exports. Therefore, choice D is the correct answer.

Question 10

A decrease in the foreign real interest rate would cause the domestic country's net exports to ________ and cause the domestic country's IS curve to ________.
A) rise; shift up
B) rise; shift down
C) fall; shift up
D) fall; shift down

Accepted Answer

The answer of A decrease in the foreign real interest...

Question 11

Which of the following is not a reason for why domestic and foreign interest rates might differ?
A) differences in transaction costs
B) differences in default risk
C) expected changes in exchange rate
D) differences in the bonds interest rate

Accepted Answer

Differences in the bonds interest rate is actually a reason for why domestic and foreign interest rates might differ. The other options - differences in transaction costs, differences in default risk, and expected changes in exchange rate - are all factors that can affect domestic and foreign interest rates.

Question 12

Under a fixed exchange rate system, if the nominal interest parity condition holds,
A) the nominal interest rates in domestic and foreign economies must be the same.
B) the inflation rates in domestic and foreign economy must be the same.
C) the real exchange rates in domestic and foreign economies must be the same.
D) the net exports in domestic and foreign economies must be the same.

Accepted Answer

The nominal interest parity condition states that under a fixed exchange rate system, the difference between the nominal interest rates in two economies should be equal to the expected change in the exchange rate. Therefore, if this condition holds, the nominal interest rates in domestic and foreign economies must be the same, as any difference would lead to a change in the exchange rate, which is not allowed under the fixed exchange rate system.

Question 13

In an open economy, an increase in net exports because of increased demand for domestic products by foreigners should cause the domestic real interest rate to ________ and should cause desired saving minus desired investment to ________.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Accepted Answer

An increase in net exports will lead to an increase in demand for domestic products, which will lead to an increase in the demand for domestic currency. This will cause the exchange rate to appreciate, making exports more expensive and imports cheaper. Since net exports have increased, there will be an excess demand for domestic goods and services, which will lead to an increase in the domestic interest rate. The increase in the domestic interest rate will make domestic bonds more attractive to foreign investors, leading to an increase in the demand for domestic currency and a further increase in the exchange rate. 
Therefore, an increase in net exports should cause the domestic real interest rate to rise and should cause desired saving minus desired investment to rise as well.

Question 14

Which of the following statements is true?
A) The open-economy IS curve is derived in the same way that the closed-economy IS curve is derived.
B) The closed-economy IS curve is downward sloping, but the open-economy IS curve is upward sloping.
C) Some factors that shift the IS curve in the closed economy in one direction will shift the IS curve in the open economy in the opposite direction.
D) Factors that raise a country's current net exports, given domestic output and the domestic real interest rate, shift the open-economy IS curve up.

Accepted Answer

Factors that raise a country's current net exports shift the open-economy IS curve up. This is because an increase in net exports implies an increase in aggregate demand for domestic goods and services, which in turn leads firms to increase output. The other statements are false. The open-economy IS curve is derived differently from the closed-economy IS curve, and both are downward sloping. Factors that shift the IS curve in one direction in the closed economy will shift it in the same direction in the open economy, not in the opposite direction.

Question 15

A temporary decrease in government purchases would ________ the domestic real interest rate and ________ net desired saving (desired saving less desired investment) in the economy.
A) lower; increase
B) lower; decrease
C) raise; increase
D) raise; decrease

Accepted Answer

The answer of A temporary decrease in government purchases would...

Question 16

All else being equal in a classical model, a temporary decrease in government expenditures in the United States would cause the Canadian real interest rate to ________ and the Canadian price level to ________.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Accepted Answer

The answer of All else being equal in a classical...

Question 17

In a small open economy with flexible exchange rates, a fiscal contraction would
A) increase domestic output.
B) decrease domestic output.
C) have no effect on domestic output.
D) cause an exchange rate appreciation.

Accepted Answer

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

Question 18

The net export crowding out effect refers to a situation in which
A) a fiscal expansion causes the local currency to appreciate reducing the net exports.
B) a fiscal contraction causes the local currency to depreciate reducing the net exports.
C) a monetary expansion causes the local currency to appreciate reducing the net exports.
D) a monetary expansion causes the local currency to depreciate increasing the net exports.

Accepted Answer

The net export crowding out effect refers to a situation in which a fiscal expansion (an increase in government spending and/or decrease in taxes) causes an increase in demand for goods and services, which leads to an increase in the demand for local currency. This increase in demand for local currency causes the currency to appreciate, which in turn makes exports more expensive and reduces net exports.

Question 19

The Canadian interest rate is 4 percent and the US interest rate is 6 percent. If the interest parity condition holds, we expect
A) the Canadian dollar to appreciate by 2 percent.
B) the Canadian dollar to depreciate by 6 percent.
C) the US dollar to depreciate 2 percent.
D) the US dollar to appreciate by 2 percent.

Accepted Answer

The answer of The Canadian interest rate is 4 percent...

Question 20

Which of the following changes would cause Canadian net exports to decrease?
A) a decrease in the real value of the dollar
B) a decrease in Canadian income
C) an increase in foreign income
D) a shift in demand by Canadian consumers away from domestically produced goods

Accepted Answer

If Canadian consumers shift their demand away from domestically produced goods, they will likely begin to consume more foreign goods which will increase imports, while decreasing exports. This decrease in net exports is likely to continue until the demand for domestically produced goods is restored.

Quiz 10: Exchange Rates, Business Cycles, and Macroeconomic Policy in the Open Economy

Which of the following statements describes the interest parity condition?

Which of the following changes would cause Canadian net exports to increase?

A decrease in foreign output would cause the domestic country's net exports to and cause the domestic country's IS curve to .

A decline in the domestic real interest rate would cause a in net exports and a in the exchange rate.

An increase in the Canadian money supply would cause the value of the dollar to and net Canadian exports to in the short run using a Keynesian model.

In a Keynesian model, a temporary decrease in government purchases would cause output to and the domestic real interest rate to .

The Canadian real interest rate rises relative to the British real interest rate. British net exports and the British exchange rate .

In the short run in the Keynesian model, an increase in the domestic money supply would cause domestic output to and the domestic real interest rate to .

Goods market equilibrium in the open economy occurs when

A decrease in the foreign real interest rate would cause the domestic country's net exports to and cause the domestic country's IS curve to .

Which of the following is not a reason for why domestic and foreign interest rates might differ?

Under a fixed exchange rate system, if the nominal interest parity condition holds,

In an open economy, an increase in net exports because of increased demand for domestic products by foreigners should cause the domestic real interest rate to and should cause desired saving minus desired investment to .

Which of the following statements is true?

A temporary decrease in government purchases would the domestic real interest rate and net desired saving (desired saving less desired investment) in the economy.

All else being equal in a classical model, a temporary decrease in government expenditures in the United States would cause the Canadian real interest rate to and the Canadian price level to .

In a small open economy with flexible exchange rates, a fiscal contraction would

The net export crowding out effect refers to a situation in which

The Canadian interest rate is 4 percent and the US interest rate is 6 percent. If the interest parity condition holds, we expect

Which of the following changes would cause Canadian net exports to decrease?