Question 1

Consider the following scenario. The Swiss franc is fixed to the U.S. dollar. Market pressures lead to a move away from the peg. Which of the following can be used to restore the previous peg?

Accepted Answer

The Swiss central bank can use its foreign exchange reserves to purchase or sell U.S. dollars in order to restore the previous peg. This is a common strategy used by central banks to maintain fixed exchange rates. Using a commodity such as gold (A) may not be practical or feasible. Lowering domestic prices (B) would be difficult to implement and could lead to deflation. Allowing the exchange by the market (C) could result in significant volatility and uncertainty in the short term, which could have negative consequences for the Swiss economy.

Question 2

An example of a fixed exchange rate was the gold standard.

Accepted Answer

The gold standard was a fixed exchange rate system in which a country's currency was backed by a fixed amount of gold.

Question 3

A managed floating exchange rate is a market determined exchange system as long as rates stay between target zones as mandated by legislative commitments.

Accepted Answer

A managed floating exchange rate involves a government or central bank influencing the exchange rate through buying and selling currencies, rather than letting it be entirely determined by market forces, even though it may not have specific target zones mandated by legislation.

Question 4

The introduction of the Bretton Woods system meant that the Federal Reserve had to take an active role in managing currency exchange rates.

Accepted Answer

The answer of The introduction of the Bretton Woods system...

Question 5

"Dollarization" and currency boards are examples of exchange rate systems that provide relatively large independent monetary policy as compared to floating exchange rates.

Accepted Answer

Both dollarization and currency boards involve fixing the exchange rate of a country's currency to that of another country (usually the US dollar). This greatly limits the ability of the country to pursue independent monetary policy, as changes in interest rates and other monetary policy tools will have little effect on the exchange rate. In contrast, floating exchange rates allow countries to adjust their monetary policy to suit their economic conditions without being tied to another currency.

Question 6

A pegged exchange rate is: I. Fixed to a currency or basket of currencies
II) Responds to indicators such as inflation differentials)
III) May require intervention to maintain the target pegged rate

Accepted Answer

A pegged exchange rate is fixed to a currency or a basket of currencies and may require intervention to maintain the target pegged rate. It does not necessarily respond to indicators such as inflation differentials, so option II is not always true. Therefore, options I and III are the best choices.

Question 7

What is seignorage?

Accepted Answer

Seignorage refers to the profit a government earns by printing money and using it to purchase assets that earn a return. The difference between the cost of printing the money and the return earned on the assets is the seignorage. It is essentially a form of profit from the government's ability to create currency.

Question 8

Why was the European Monetary System established?

Accepted Answer

The European Monetary System was established in 1979 to maintain small exchange rate fluctuations among member countries. It aimed to create stability and boost economic growth by coordinating monetary policies and limiting currency fluctuations. The system was an important step towards the establishment of the euro, but it did not create a common currency. The other options (A, B, and D) are incorrect as they do not reflect the purpose or goals of the European Monetary System.

Question 9

An example of an optimal currency area would be

Accepted Answer

The United States is an example of an optimal currency area due to its high degree of labor mobility, a federal system of government with a powerful central bank, and a homogenous culture and language. These factors facilitate the adjustment process to external shocks and make it easier to maintain a stable currency. Southeast Asia and Latin America, on the other hand, are not considered optimal currency areas due to their lower degree of labor mobility, diverse cultures and languages, and weaker institutional frameworks.

Question 10

Consider the following scenario. The Swiss franc is operating under a managed float exchange system. Under this system, what actions can the Swiss central bank take to influence the current exchange?

Accepted Answer

Under a managed float exchange system, the central bank can intervene in the foreign exchange market by purchasing or selling foreign currencies to influence the exchange rate. This is done in order to maintain stable exchange rates and prevent volatility. Option B and C are not commonly used in a managed float exchange system, and Option D is related to monetary policy rather than exchange rate management.

Question 11

In general, the smaller the country is, the more likely it is to peg its exchange rate.

Accepted Answer

Smaller countries may have less developed financial markets and more limited reserves, making it harder for them to withstand currency fluctuations. Therefore, they may choose to peg their exchange rates as a way to maintain stability and attract foreign investment.

Question 12

What exchange rate system allows for periodic intervention without fixing to any other foreign currency?

Accepted Answer

Horizontal band exchange rate systems allow for periodic intervention by the central bank to maintain the currency's value within a specified range or band, without fixing it to another currency's value.

Quiz 2: Tools of Analysis for International Trade Models