Question 1

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 2

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 a central bank buys or sells foreign currency while simultaneously buying or selling domestic assets (such as Treasury securities) in order to offset the impact on the domestic money supply. In this case, the Fed's actions would increase the demand for dollars and also increase the supply of Treasury securities, which would help sterilize the impact on the money supply.

Question 3

Which of the following is not true regarding government intervention?

Accepted Answer

Under the direct method of intervention, the government would intervene by buying or selling domestic currency in the foreign exchange market. The exchange of dollars for foreign currencies would be a part of indirect intervention.

Question 4

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 5

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 weaker currency can make exports cheaper and more attractive, leading to increased demand and employment in the domestic economy. However, it also makes it more expensive to import goods, causing an increase in the prices of imported goods. Domestic companies may also increase their prices, as they face less competition from foreign companies with stronger currencies. This can lead to higher inflation in the domestic economy.

Question 6

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

Accepted Answer

Direct intervention involves buying or selling currency and is typically used by central banks to influence short-term exchange rates. Indirect intervention, on the other hand, involves using monetary or fiscal policies to impact macroeconomic variables such as inflation, interest rates, and economic growth, which can ultimately affect exchange rates in the long run. Choice C is an example of indirect intervention because the Fed is attempting to strengthen the dollar by addressing a fundamental issue in the economy (inflation), rather than directly buying or selling currency.

Question 7

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 home currency makes goods and services more expensive for foreign buyers, making exports less competitive and imports more attractive. This can lead to a decrease in demand for domestic products and an increase in demand for foreign products, which can lead to lower production and higher unemployment.

Question 8

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

Accepted Answer

By weakening its currency, a government can make its exports more competitive and potentially boost demand, leading to increased economic activity.

Question 9

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 refers to the methods used by central banks, such as the Fed, to influence the exchange rate of their currencies by affecting the underlying economic and financial factors. By adjusting interest rates, the Fed can influence the demand for U.S. dollars, which can affect the exchange rate. This is considered an indirect form of intervention.

Question 10

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 allowed to fluctuate in response 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 or pegged exchange rate system.

Question 11

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 a currency is determined by the market forces of supply and demand. If the U.S. experiences high inflation, the value of the dollar may decrease relative to other currencies, resulting in more expensive imports for American consumers. This can lead to less competition from foreign producers and potentially higher prices for domestic consumers.

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

Among the reasons for government intervention are:

Accepted Answer

Government intervention in foreign exchange markets can serve different purposes, including smoothing exchange rate movements, establishing implicit exchange rate boundaries, and responding to temporary disturbances. Smoothing exchange rate movements can help reduce volatility and uncertainty in international trade and investment, which can facilitate economic growth and stability. Establishing implicit exchange rate boundaries can signal to market participants what exchange rate levels are deemed sustainable and desirable by the government, which can influence expectations and behavior. Responding to temporary disturbances, such as sudden currency appreciation or depreciation, can help mitigate the impacts of such shocks on trade competitiveness, inflation, and financial stability. Therefore, all of the above reasons are valid justifications for government intervention in foreign exchange markets.

Question 14

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

Accepted Answer

Countries may face difficulty maintaining a pegged exchange rate during times of crisis or instability, as market forces can put pressure on the currency and make it difficult for the central bank to maintain the peg. This can result in the collapse of the peg and devaluation of the currency.

Question 15

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 are required to constantly intervene in the foreign exchange market to maintain exchange rates within specified boundaries. This is because the exchange rate is fixed by the government and they must take action to ensure it stays at that fixed rate.

Question 16

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 rate between countries is fixed, so changes in the inflation rate in one country will affect the relative prices of goods and services produced in that country compared to other countries. This can lead to spillover effects on inflation in other countries that trade with the fixed exchange rate country. In contrast, under a freely floating exchange rate system, the exchange rate adjusts to changes in inflation rates, which can help to insulate other countries from the effects of inflation in a particular country.

Question 17

Which of the following is true regarding the euro?

Accepted Answer

All of the given options are true regarding the euro. The elimination of exchange rate risk, consistency in economic conditions, and a common monetary policy are some of the benefits of euro adoption.

Quiz 6: Government Influence on Exchange Rates