Question 1

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 makes foreign goods cheaper, making exports more expensive and therefore potentially reducing demand for domestically produced goods. This can lead to a decrease in employment opportunities within the home country.

Question 2

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

Accepted Answer

Pegged exchange rate systems are often difficult to maintain, especially during times of economic or political crisis. Countries may struggle to keep up with the required currency interventions and may face pressure from market speculators, leading to a devaluation of their currency. There have been many instances of countries abandoning their pegged exchange rates due to these challenges.

Question 3

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 constantly intervene in the foreign exchange market to maintain exchange rates within specified boundaries. This is because the government sets a specific exchange rate and must take action to buy or sell currency to maintain that rate.

Question 4

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 can make exports more attractive, leading to increased demand for goods produced by local companies. This can lead to an increase in their prices, which can result in higher inflation.

Question 5

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 betting against it, not by investing in Mexico.

Question 6

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 value of a country's currency is tied to the value of another currency. This means that if the U.S. experiences inflation, causing the value of the U.S. dollar to decrease, the value of other countries' currencies tied to the U.S. dollar would also decrease, leading to inflation in those countries as well. Under a freely floating exchange rate system, the value of a country's currency is determined by market forces and is not directly tied to any other currency, so U.S. inflation would have less impact on inflation in other countries.

Question 7

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

Accepted Answer

If the government weakens its currency, it becomes cheaper for other countries to import goods from it, which in turn can increase demand for exports and thus stimulate the economy. This is one of the tools that can be used under a managed float system to try to boost economic growth.

Question 8

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

The answer of Assume that the dollar has been consistently...

Question 9

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, the value of the currency is determined by supply and demand in the foreign exchange market. If the U.S. experiences higher inflation, the value of the dollar will decrease relative to other currencies, causing foreign imports to become more expensive. This can lead to reduced competition from foreign producers, as their goods will be more expensive compared to domestic goods. Therefore, a high U.S. inflation rate can be magnified in a freely floating exchange rate system.

Question 10

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

Indirect intervention is a common tool used by central banks like the Federal Reserve to influence the value of their currency. The Fed can indirectly affect the dollar's value by manipulating key factors like interest rates, which can impact factors like inflation and foreign investment in the country. This can in turn influence the supply and demand for the dollar, ultimately impacting its value against other currencies.

Question 11

Which of the following is true regarding the euro?

Accepted Answer

A) Exchange rate risk is eliminated because participating European countries have a common currency, which reduces uncertainties and transaction costs, allowing for easier trade and capital flows.
B) The euro creates a monetary union, leading to more consistent economic conditions across countries, as they share a single monetary policy and exchange rate.
C) As part of the monetary union, each participating country gives up its ability to conduct monetary policy, which is now largely set by the European Central Bank.

Question 12

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 answer of Assume that the dollar has been consistently...

Question 13

Which of the following is not true regarding government intervention?

Accepted Answer

The statement under option A is not true. Under the direct method of intervention, an appreciation of the dollar would be accomplished by exchanging foreign currencies for dollars, not the other way around as stated in the option.

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

A "dirty" float, or managed float, does not have official boundaries for the exchange rate; instead, the government or central bank occasionally intervenes to stabilize or influence the currency's value without fixed limits.

Question 15

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 refers to when the central bank buys or sells foreign currency while also conducting offsetting transactions in domestic securities. In this case, the Fed is buying dollars but also buying Treasury securities, which would have a neutral effect on the money supply, making it a sterilized intervention.

Question 16

Among the reasons for government intervention are:

Accepted Answer

All of the given reasons are valid justifications for government intervention in the foreign exchange market. Governments may choose to intervene to smooth out volatile currency movements, to establish implicit boundaries for their exchange rates, or to respond to temporary disturbances such as sudden spikes or drops in the value of their currency.

Question 17

Which of the following is an appropriate form of indirect intervention?

Accepted Answer

Indirect intervention refers to policies that aim to achieve a specific goal without directly intervening in the market. Option C is an appropriate form of indirect intervention because by reducing U.S. inflation, the Fed can increase the purchasing power of the dollar, which can strengthen it in the long run. Options A and B are forms of direct intervention because the Fed is manipulating the money supply to directly affect interest rates. Option D is also a form of indirect intervention, but it contradicts economic theory - reducing U.S. inflation would typically strengthen the dollar, not weaken it.

Quiz 6: Government Influence on Exchange Rates