3. If the price of a British pound increases from $1.50 per pound to $1.80 per pound, we say that:

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1 STUDY GUIDE FINAL ECO41 FALL 2013 UDAYAN ROY Ch 13 National Income Accounting See the questions in Homework 7 and Homework 8. CHAPTER 14 Exchange Rates and Interest Parity 1. How many dollars would it cost to buy an Edinburgh Woolen Mill sweater costing 50 British pounds if the exchange rate is 1.50 dollars per one British pound? a. 50 dollars b. 75 dollars c. 80 dollars d. 90 dollars 2. How many dollars would it cost to buy an Edinburgh Woolen Mill sweater costing 50 British pounds if the exchange rate is 1.80 dollars per one British pound? a. 50 dollars b. 75 dollars c. 80 dollars d. 90 dollars 3. If the price of a British pound increases from $1.50 per pound to $1.80 per pound, we say that: a. The dollar has appreciated and the pound has depreciated b. the dollar has depreciated and the pound has appreciated c. the dollar has appreciated and the pound has appreciated d. the dollar has depreciated and the pound has depreciated 4. When the price of a British pound increases from $1.50 per pound to $1.80 per pound, a. Americans find that Britain s exports are more expensive, and British residents find that imports from America are more expensive. b. Americans find that Britain s exports are more expensive, and British residents find that imports from America are less expensive. c. Americans find that Britain s exports are cheaper; however, British residents are not affected. d. Americans are not affected, but British residents find that imports from America are more expensive. 5. An increase in the value of a country s currency a. Decreases the relative price of its exports and lowers the relative price of its imports. b. Raises the relative price of its exports and raises the relative price of its imports. c. Lowers the relative price of its exports and raises the relative price of its imports. d. Raises the relative price of its exports and lowers the relative price of its imports.

2 6. If we assume that all other relevant factors are unchanged, an increase in the value of a country s currency will a. Increase its exports, decrease its imports, and thereby increase its current account balance b. Decrease its exports, increase its imports, and thereby increase its current account balance c. Increase its exports, decrease its imports, and thereby decrease its current account balance d. Decrease its exports, increase its imports, and thereby decrease its current account balance e. Increase both exports and imports 7. The exchange rate between currencies depends on a. The interest rates that can be earned on deposits in those currencies. b. The expected future exchange rate. c. The interest rates that can be earned on deposits in those currencies and the expected future exchange rate. d. National output. 8. Suppose you must decide whether to keep your money in America or in Europe. If the interest rate on bank deposits in dollars is 10% and the interest rate on bank deposits in euros is 6%, then a. You should invest only in dollar deposits. b. You should invest only in euro deposits. c. You should invest in both dollar deposits and euro deposits. d. It is impossible to tell, given the information, what you should do. e. All of the above. 9. Even if the interest rate on bank deposits in dollars is 10% and the interest rate on bank deposits in euros is 6%, a rational person may keep her money in euros if a. The euro is expected to appreciate (with respect to the dollar) b. The euro is expected to depreciate c. Inflation is expected to be higher in Europe compared to the US d. Inflation is expected to be lower in Europe compared to the US 10. Which of the following statements is the most accurate? a. A rise in the interest rate offered for dollar bank deposits (R $ ) causes the dollar to appreciate. b. A rise in the interest rate offered for dollar bank deposits (R $ ) causes the dollar to depreciate. c. A rise in the interest rate offered for dollar bank deposits (R $ ) does not affect the U.S. dollar. d. For a fixed euro interest rate (R ) and a fixed expected exchange rate (E e $/ ), a rise in the dollar interest rate (R $ ) causes the dollar to appreciate. 11. If the interest rate paid by US banks (R $ ) is 6 percent and the interest rate paid by European banks (R ) is 4 percent, the theory of interest parity says that people probably expect 2

3 a. The dollar to increase in value by 2 percent b. The euro to increase in value by 2 percent c. The dollar to increase in value by 10 percent d. The euro to increase in value by 10 percent 12. What is the equation that represents the interest parity condition? a. R $ = R + (E e $/ E $/ ) / E $/. b. R = R $ + (E e $/ E $/ ) / E $/. c. R $ = R + (E e /$ E /$ ) / E /$. d. R $ = R - (E e $/ E $/ ) / E $/. 13. If all interest rates stay unchanged, the theory of interest parity says that an increase in the expected future value of the euro (E e $/ ) will a. cause the value of the euro (E $/ ) to increase immediately b. cause the value of the euro (E $/ ) to decrease immediately c. have no effect on the value of the euro (E $/ ) immediately d. cause the value of the euro (E $/ ) to increase, but only in the long run 14. When the interest parity equation is satisfied, a. The goods market is in equilibrium b. The money market is in equilibrium c. The foreign exchange market is in equilibrium d. All of the above e. None of the above CHAPTER 15 Money market equilibrium 15. The aggregate money demand (M d ) is a. The portion of the aggregate wealth of the nation s people that they would like to hold in the form of financial assets such as stocks and bonds b. The portion of the aggregate wealth of the nation s people that they would like to hold in the form of liquid assets such as cash and checking accounts c. The portion of the aggregate wealth of the nation s people that they would like to hold in the form of liquid assets such as stocks and bonds d. The wealth that the nation s people consider adequate for a comfortable life 16. The aggregate money demand depends on a. The interest rate b. The price level c. Real gross national product d. All of the above. e. Only (a) and (c) 3

4 17. The aggregate money demand a. Depends directly on the interest rate (R) and price level (P), and inversely on real GNP (Y). b. Depends directly on Y and R, and inversely on P. c. Depends directly on Y and P, and inversely on R. d. Depends directly on R, and inversely on P and Y. 18. The aggregate demand for money can be expressed by: a. M d = P L(R,Y) b. M d = L P(R,Y) c. M d = Y P(R, L) d. M d = R L(P,Y) e. M d = R L(R, P) 19. Let L be the aggregate real demand for money (or, equivalently, the purchasing power of the aggregate amount of money demanded). An increase in a. real GNP (Y) reduces the aggregate real money demand at a given interest rate (R). b. real GNP raises the aggregate real money demand at a given interest rate. c. the interest rate raises the aggregate real money demand at a given real GNP. d. real GNP reduces aggregate nominal money demand for a given interest rate 20. When the curve of the supply of money is graphed with the interest rate (R) on the vertical axis and the supply of money (M s ) on the horizontal axis, the curve is a. horizontal because M s is set by the central bank. b. vertical because M s is set by the central bank. c. vertical because M s is set by the households and firms. d. just a point because M s and R are both set by the central bank. e. vertical because R is set by the central bank. 21. When the supply of money is equal to the demand for money (that is, M s = M d ) we have a. equilibrium in the money market b. equilibrium in the foreign exchange market c. equilibrium in both the money market and the foreign exchange market d. equilibrium un the goods and services market e. none of the above 22. Using the equation for equilibrium in the money market, indicate which one of the following statements is the most accurate? a. A decrease in the money supply (M s ) lowers the interest rate (R) while an increase in the money supply raises the interest rate, at any given price level (P) and output (Y). b. An increase in the money supply lowers the interest rate while a fall in the money supply raises the interest rate, at any given price level. 4

5 c. An increase in the money supply lowers the interest rate while a fall in the money supply raises the interest rate, at any given output level. d. An increase in the money supply lowers the interest rate while a fall in the money supply raises the interest rate, at any given price level and output. 23. Using the equation for equilibrium in the money market, we can predict that an increase in a. nominal output raises the interest rate while a fall in real output lowers the interest rate, given the price level and the money supply. b. real output decreases the interest rate while a fall in real output increases the interest rate, given the price level. c. real output raises the interest rate while a fall in real output lowers the interest rate, given the money supply. d. nominal output raises the interest rate while a fall in real output lowers the interest rate, given the price level. e. real output raises the interest rate while a fall in real output lowers the interest rate, given the price level and the money supply. 24. Assume that the nominal interest rate (R) stays constant over time in the long-run macroeconomic equilibrium. If the central bank is increasing the nation s money supply at a steady annual rate of 5%, and if the nation s potential GNP is increasing at the steady annual rate of 2%, then in the longrun macroeconomic equilibrium, the nation s annual rate of inflation will be a. 7% b. 3% c. 2.5% d. 3% e. Some value that cannot be calculated from the information given CHAPTER 16 PRICE LEVELS AND THE EXCHANGE RATE IN THE LONG RUN 25. Which of the following statements is the most accurate? The law of one price (also known as absolute purchasing power parity) states: a. In competitive markets free of transportation costs and official barriers to trade, identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency. b. In competitive markets free of transportation costs and official barriers to trade, identical goods sold in the same country must sell for the same price when their prices are expressed in terms of the same currency. c. In competitive markets free of transportation costs and official barriers to trade, identical goods sold in different countries must sell for the same price. d. Identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency. e. None of the above 26. Let E $/ be the dollars-per-euro exchange rate, and let P US and P E be the overall price levels in USA and Europe, respectively. Under absolute purchasing power parity, 5

6 a. E $/ = P US /P E b. E $/ = P E /P ES c. E $/ = P US + P E d. E $/ = P US P E 27. Suppose the annual inflation rates in the USA and in Japan are 2% and 1%, respectively. Then, under absolute purchasing power parity, the dollars-per-yen exchange value of the yen will a. remain roughly constant over time b. decrease at the annual rate of 1% c. increase at the annual rate of 1% d. decrease at the annual rate of 3% e. increase at the annual rate of 3% 28. In the theory of long-run international macroeconomic equilibrium that was discussed in class, a nation s nominal interest rate (R) depends a. Directly on the growth rate of its money supply b. Inversely on the growth rate of its potential GNP c. Directly on the foreign nominal interest rate (R*) d. Inversely on the foreign inflation rate (π*) e. All of the above 29. Suppose the annual inflation rates in the USA and in Japan are 2% and 1%, respectively. Also, suppose the interest rate paid by Japanese banks is 3% per year. Then, under absolute purchasing power parity and interest parity (Ch. 14), the interest rate paid by American banks will be a. 0% b. 2% c. 3% d. 5% e. 6% 30. In the long run, a country s output (that is, real GNP, Y) a. Fluctuates around its potential output (Y p ) b. Is usually higher than its potential output c. Is usually lower than its potential output d. Is usually equal to its potential output e. Is largely unrelated to its potential output 31. In the long run, a country s inflation rate a. Is equal to the rate at which the country s money supply is being increased by its central bank b. Is equal to the rate of increase of the money supply minus the rate of increase of the country s potential output c. Is equal to the rate of increase of the money supply plus the rate of increase of the country s potential output d. Is unrelated to the rate of increase of the money supply and the rate of increase of the country s potential output e. Is equal to the domestic interest rate minus the foreign interest rate 6

7 32. Assuming other exogenous variables are unaffected, if a country s central bank increases the rate at which it increases the country s money supply from 4% per year to 6% per year, which of the following long-run changes will occur? (Assume the country has a system of freely floating exchange rates.) a. The rate of inflation will rise by 2 percentage points b. The exchange value of the country s currency will fall by 2 percentage points c. The rate of interest paid by the country s banks will rise by 2 percentage points d. Real GNP (Y) and the real exchange rate (q) will be unaffected e. All of the above 33. In the long run, a country s price level will rise if a. The money supply increases b. The growth rate of the money supply increases c. Potential output decreases d. The growth rate of potential output decreases e. All of the above 34. According to the theory of an open economy with freely floating exchange rates that was discussed in class, if the rate of inflation increases in a foreign country, how will the domestic economy be affected in the long run? a. its inflation rate will increase b. its price level will increase c. the exchange value of its currency will decrease d. its real GNP and real exchange rate will both increase e. none of the above will happen 35. The idea that in the long run a country s inflation rate and interest rate tend to move together (in the same direction and to the same extent) is called a. The quantity theory of money b. Absolute purchasing power parity c. Uncovered interest parity d. Fisher effect 36. In the long run, a country s interest rate is affected by a. Both the level and the rate of growth of the money supply that is generated by its central bank b. The level but not the rate of growth of the money supply c. The rate of growth but not the level of the money supply d. Neither the level nor the rate of growth of the money supply 37. According to purchasing power parity, in the long run, higher prices in the foreign country will be accompanied by a. Higher value of the foreign country s currency b. Lower value of the foreign country s currency c. Higher prices in the domestic country d. Higher output in the domestic country e. Both (a) and (c) are correct 7

8 38. Under fixed exchange rates, the expected rate of appreciation of the foreign currency is zero. Therefore, assuming absolute purchasing power parity, it must be that a. the foreign inflation rate equals the domestic inflation rate b. the foreign inflation rate equals the domestic inflation rate plus the domestic interest rate c. the foreign inflation rate is less than the domestic inflation rate d. the foreign inflation rate is unrelated to the domestic inflation rate 39. Absolute purchasing power parity is the assumption that a. The domestic price level (P) is equal to the foreign price level multiplied by the value of the foreign currency in units of the domestic currency, in order to express all prices in the same currency. Therefore, P = E P*. This also implies that the real exchange rate is q = 1. b. The real exchange rate is constant, though not necessarily equal to 1. c. The domestic price level (P) is equal to the foreign price level (P*) once foreign prices are multiplied by the value of the foreign currency in units of the domestic currency (E) in order to express all prices in the same currency. Therefore, the real exchange rate is constant, though not necessarily equal to 1. d. The domestic interest rate (R) is equal to the foreign interest rate (R*) plus the expected rate of appreciation of the foreign currency. 40. Relative Purchasing Power Parity is the assumption that a. The domestic price level (P) is equal to the foreign price level (P*) once foreign prices are multiplied by the value of the foreign currency in units of the domestic currency (E) in order to express all prices in the same currency. Therefore, P = E P*. This also implies that the real exchange rate is q = 1. b. The real exchange rate is constant, though not necessarily equal to 1. c. The domestic price level (P) is equal to the foreign price level (P*) once foreign prices are multiplied by the value of the foreign currency in units of the domestic currency (E) in order to express all prices in the same currency. Therefore, the real exchange rate is constant, though not necessarily equal to 1. d. The domestic interest rate (R) is equal to the foreign interest rate (R*) plus the expected rate of appreciation of the foreign currency. 41. Under absolute purchasing power parity, a. The expected rate of appreciation of the foreign currency is equal to the excess of the foreign inflation rate over the domestic inflation rate b. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency s value is expected to appreciate by 2% c. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency s value is expected to depreciate by 2% d. If the foreign interest rate is 7% and the domestic interest rate is 5%, the foreign currency s value is expected to depreciate by 2% 42. Under interest rate parity (Ch. 14), 8

9 a. The expected rate of appreciation of the foreign currency is equal to the excess of the foreign inflation rate over the domestic inflation rate b. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency s value is expected to appreciate by 2% c. If the foreign inflation rate is 7% and the domestic inflation rate is 5%, the foreign currency s value is expected to depreciate by 2% d. If the foreign interest rate is 7% and the domestic interest rate is 5%, the foreign currency s value is expected to depreciate by 2% Chapter 17 Output and the Exchange Rate in the Short Run 43. Revisiting the discussion in Chapter 14 of interest parity (or, equilibrium in the foreign currency market), the value of the foreign currency increases (E ) when (and the other variables in the interest parity equation are unchanged). a. R decreases. b. R * increases. c. E e increases. d. All of the above. 44. Revisiting the discussion in Chapter 15 of equilibrium in the money market, the domestic interest rate increases (R ) when (and the other variables in the money market s equilibrium equation are unchanged). a. M s /P decreases b. Y increases c. All of the above d. M s /P increases e. Y decreases 45. Combining the issues discussed in the last two questions, simultaneous equilibrium in both the currency market and the money market implies that E increases when (and the other variables in the equilibrium equations are unchanged). a. M s /P increases. b. Y decreases. c. E e increases. d. R* increases e. All of the above. f. None of the above. 46. In the theory of short-run international macroeconomics that was discussed in class, it is assumed that price levels stay fixed at historical levels. Under such sticky prices, if the central bank increases the nation s money supply, there would be a. A decrease in the interest rate b. An increase in the interest rate c. No effect on the interest rate 9

10 d. None of the above statements is true. 47. How does an increase in the real exchange rate (q ) affect exports and imports? a. Exports increase; imports decrease. b. Exports decrease; imports increase. c. Exports increase; imports change ambiguously. d. Exports change ambiguously; imports decrease. e. Exports increase; imports are constant. 48. How does a rise in real income (Y ) affect aggregate demand? a. Y Im CA AD, but Y C AD by more b. Y Im CA AD, but Y C AD by more c. Y Im CA AD, and Y C AD d. Y Im CA AD, but Y C AD by less e. Y Im CA AD, but Y C AD by less 49. Expansionary monetary policy refers to. a. An increase in the money supply (M s ) b. A decrease in the money supply c. An increase in government purchases (G ) and/or a cut in taxes (T ) d. A decrease in government purchases and/or a hike in taxes 50. Expansionary fiscal policy refers to. a. An increase in the money supply (M s ) b. A decrease in the money supply c. An increase in government purchases (G ) and/or a cut in taxes (T ) d. A decrease in government purchases and/or a hike in taxes 51. If the economy starts at long-run equilibrium, a permanent fiscal expansion will cause a. An increase in exchange rate, E b. A decrease in exchange rate, E c. An increase in long-run output, Y d. A decrease in long-run output, Y e. Shifting of the AA curve up and to the right 52. Which of the following is true? a. Expansionary monetary policy increases the current account balance (CA). b. Expansionary monetary policy decreases the current account balance. c. Expansionary fiscal policy increases the current account balance. d. Expansionary fiscal policy decreases the current account balance. e. Both (a) and (d) are true 10

11 53. In the short run, with prices fixed, how would an increase in government spending affect national income and the value of the nation s currency? a. It will increase output and appreciate the currency. b. It will increase output and depreciate the currency. c. It will decrease output and appreciate the currency. d. It will decrease output and depreciate the currency. 54. Which one of the following statements is the most accurate? a. An increase in disposable income improves the current account. b. An increase in disposable income does not affect the current account. c. An increase in disposable income worsens the current account. d. An increase in income worsens the current account. e. An increase in income improves the current account. 55. In the short-run, any rise in foreign prices (P* ) and/or a fall in domestic prices (P ) will cause a. Either the DD curve or the AA curve or both to shift to the right. As a result, GNP will decrease b. Either the DD curve or the AA curve or both to shift to the right. As a result, GNP will increase c. Either the DD curve or the AA curve or both to shift to the left. As a result, GNP will decrease d. Either the DD curve or the AA curve or both to shift to the left. As a result, GNP will increase e. Either the DD curve or the AA curve or both to shift to the right. But GNP will be unchanged 56. In the short-run, a temporary increase in the money supply (Ms ) a. Shifts the AA curve to the right, increases output (Y ) and depreciates the currency (E ) b. Shifts the AA curve to the left, increases output and depreciates the currency c. Shifts the AA curve to the left, decreases output and depreciates the currency d. Shifts the AA curve to the left, increases output and appreciates the currency e. Shifts the AA curve to the right, increases output and appreciates the currency 57. In the short-run, expansionary fiscal policy causes a. A shift of the DD curve to the left, output increases (Y ) and the currency appreciates (E ) b. A shift of the DD curve to the right, output decreases and the currency appreciates c. A shift of the DD curve to the right, output increases and the currency depreciates d. A shift of the DD curve to the left, output decreases and the currency depreciates e. A shift of the DD curve to the right, output increases and the currency appreciates 58. The DD schedule shows all combinations of two variables for which the output market is in equilibrium. Which two variables? a. Imports and exports. b. Exports and the exchange rate. c. Foreign prices and the exchange rate. d. Output and the exchange rate. 11

12 e. Output and exports. 59. How is the AA schedule derived? a. It is derived by the schedule of interest rate and output combinations that are consistent with equilibrium in the domestic money market and the foreign exchange market. b. It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the foreign money market and the domestic exchange market. c. It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the domestic money market and the foreign exchange market. d. It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the domestic bond market and the foreign asset market. 60. The goods market is in equilibrium when a. Y = C + I + G + exports b. Y = C + I + G + exports imports c. Y = C + I + G + exports + imports d. M s = L(R) P Y. 61. The economy is in recession, GNP is falling and unemployment is soaring. You are the president s economic adviser. The president faces a tough re-election campaign and wants a quick increase in GNP. Based on the AA-DD analysis that was discussed in class, what policies would you recommend to her? a. Cut taxes b. Increase government spending c. Increase the money supply d. Raise tariffs on imported goods e. Any or all of the above 62. You are the president s economic adviser. The president faces a tough re-election campaign and wants a quick increase in the nation s current account balance. Based on the AA-DD analysis that was discussed in class, what policies would you recommend to her? a. Expansionary fiscal policy b. Contractionary fiscal policy (or, fiscal austerity) c. Expansionary monetary policy d. Contractionary monetary policy e. Both (b) and (c) would be good advice Chapter 18 Fixed Exchange Rates and Foreign Exchange Intervention 63. Suppose the domestic country s central bank decides to fix the exchange rate of its currency with respect to the foreign currency. Suppose the exchange value of foreign currency would rise in the absence of intervention by the central banks. What would the domestic country s central bank have to do to keep the exchange rate fixed? 12

13 a. Print additional amounts of the domestic currency and buy the foreign currency (on the foreign exchange market). This will increase the domestic money supply as well as the domestic central bank s stock of foreign currency. b. Use its reserves of the foreign currency to buy the domestic currency. This will reduce the domestic money supply as well as the domestic central bank s reserves of foreign currency. c. Print additional amounts of the domestic currency and buy the foreign currency. This will increase the domestic money supply and reduce the domestic central bank s reserves of foreign currency. d. Use its stock of the foreign currency to buy the domestic currency. This will increase the domestic money supply as well as the domestic central bank s reserves of foreign currency. 64. Under fixed exchange rates, the expected rate of appreciation of the foreign currency is zero. Therefore, interest parity condition (of Ch. 14) implies that a. the foreign interest rate equals the domestic interest rate b. the foreign interest rate equals the domestic interest rate plus the domestic inflation rate c. the foreign interest rate is less than the domestic interest rate d. the foreign interest rate is unrelated to the domestic interest rate 65. When a country s central bank fixes the exchange rate, it gives up its ability to a. adjust taxes b. increase government spending c. influence the economy through fiscal policy d. depreciate the domestic currency e. influence the economy by controlling the supply of money 66. When a country s currency is devalued: a. Output decreases. b. Output increases. c. The money supply decreases. d. The money supply increases. e. both (b) and (d) 67. Which one of the following statements is most true? a. Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline. b. Any central bank purchase of assets results in an increase in the domestic money supply, while any central bank sale of assets causes the money supply to decline. c. Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline. d. Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to increase. e. None of the above statement is true. 68. Under a fixed exchange rate system, the following condition should hold for domestic money 13

14 market equilibrium: a. M s /P = L(R *, Y). b. M s /P = L(R, Y). c. M d /P = L(R *, Y). d. M s = L(R *, Y). e. P = L(R *, Y). 69. Which one of the following statements is the most accurate? a. Fiscal policy has the same effect on output under fixed and flexible exchange rate regimes. b. Fiscal policy affects output more under fixed than under flexible exchange rate regimes. c. Fiscal policy affects output less under fixed than under flexible exchange rate regimes. d. Fiscal policy cannot affect output under fixed exchange rate but does affect output under flexible exchange rate regimes. e. None of the above statements are true. 70. Which one of the following statements is the most accurate? a. A devaluation occurs when the central bank lowers the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank raises E. b. A devaluation occurs when the central bank raises the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank lowers E. c. Devaluation occurs when the domestic currency price of foreign currency, E, raises and a revaluation occurs when E is lowered. d. A devaluation occurs when the central bank of the foreign country raises the domestic currency price of foreign currency, E, and a revaluation occurs when the central bank of the foreign country lowers E. e. None of the above statements is true. 71. Under fixed exchange rate, which one of the following statements is the most accurate? a. Devaluation causes a decrease in output, a decrease in official reserves, and a contraction of the money supply. b. Devaluation causes a rise in output, a rise in official reserves, and an expansion of the money supply. c. Devaluation causes a rise in output and a rise in official reserves. d. Devaluation causes a rise in output and an expansion of the money supply. e. Devaluation causes a rise in official reserves, and an expansion of the money supply. 72. Recall that absolute purchasing power parity is often assumed in long-run international macroeconomic analysis. If, in addition, the domestic economy fixes the exchange rate of its currency in terms of the foreign currency, which one of the following statements is the most accurate about the long run? a. The domestic nominal interest rate would be determined by the foreign nominal interest rate, because R = R*. b. The domestic inflation rate would be determined by the foreign inflation rate, because π = π*. 14

15 c. The domestic economy would not be able to expand its money supply to fight a recession. d. The uncertainty of exchange rate fluctuations would no longer be a big headache. e. All of the above are true. Miscellaneous 73. Tariffs, which are taxes on imported goods and services, can raise output (Y) and the current account balance (CA) a. in both the long run and the short run, under fixed exchange rates but not under flexible exchange rates b. in neither the long run nor the short run c. in the short run but not in the long run, and under fixed exchange rates but not under flexible exchange rates d. in the long run but not in the short run e. in the short run but not in the long run, and under both flexible and fixed exchange rates 74. A country can improve its the current account balance (CA) a. by implementing contractionary fiscal policy (G and/ or T ). This is effective in the short run and in the long run, under fixed exchange rates and under flexible exchange rates. b. by implementing expansionary fiscal policy (G and/ or T ). This is effective in the short run and in the long run, under fixed exchange rates and under flexible exchange rates. c. by implementing contractionary fiscal policy (G and/ or T ). This is effective only in the short run and only under flexible exchange rates. d. by implementing expansionary fiscal policy (G and/ or T ). This is effective only in the short run and only under flexible exchange rates. e. by implementing contractionary fiscal policy (G and/ or T ). This is effective only in the short run and only under fixed exchange rates. 75. Expansionary monetary policy, which consists of an increase in money supply (M s ) under flexible exchange rates and devaluation (E ) under fixed exchange rates, affects output (Y) and current account balance (CA) in the short run as follows: a. Y and CA b. Y and CA c. Y and CA d. Y and CA 76. Irrespective of the exchange rate system, expansionary fiscal policy (G and/ or T ) will cause output to increase (Y ) a. In the long run, but not in the short run b. In both the long run and the short run c. In neither the long run nor the short run d. In the short run, but not in the long run 77. Expansionary monetary policy (M s under flexible exchange rates and E under fixed exchange 15

16 rates) will cause output to increase (Y ) a. In the long run, but not in the short run b. In both the long run and the short run c. In neither the long run nor the short run d. In the short run, but not in the long run Chapter 20 Optimum Currency Areas and the European Experience 78. On January 1, 1999 a. Eleven European countries gave up their currencies and jointly adopted a single currency, the Euro. b. The Bretton Woods system of fixed exchange rates came to an end. c. A massive currency crisis, which eventually engulfed many countries in Asia, began in Thailand. d. The U.S. Treasury Department extended a $20 billion loan to Mexico to rescue it from a developing currency crisis. 79. If each of the 50 states of the United States of America had its own central bank and its own currency, then each state would be able to cope with asymmetric shocks, and the extent of trade between the states would. a. better; increase b. less; increase c. less; decrease d. better; decrease 80. Any collection of regions that use the same currency such as the towns of Nassau County, the counties of New York state, the states of the USA, etc. faces the problem of asymmetric shocks. This problem can be described as follows: When some regions have high unemployment and therefore require in the quantity of money and other regions have high inflation and therefore require in the quantity of money, the authorities that control the quantity of money would find it impossible to satisfy every region. a. increase; increase b. increase; decrease c. decrease; decrease d. decrease; decrease 81. The problem of asymmetric shocks will be less painful for the European Monetary Union if a. The economies of the EMU are so closely tied together through trade that their business cycles are largely synchronized (i.e., when one country has high unemployment so do the others and when one country has high inflation so do the others). b. It is easy for workers to move from country to country within the EMU in search of a job. c. There exists a unified budget or a system of fiscal transfers that use temporarily high tax revenues of one member country to aid those member countries with temporarily low tax revenues. 16

17 d. All of the above. 82. In theory, there is no difference between (i) a group of countries that have their own separate currencies but maintain fixed exchange rates between those currencies and (ii) a group of countries that adopt a single currency. Yet it made sense for twelve European countries to form a monetary union because a. System (i) is vulnerable to currency crises especially when there are no restrictions on capital flows whereas system (ii) is not. b. The single currency was intended as a potent symbol of Europe s desire to place cooperation ahead of the national rivalries that often had led to war in the past. c. In a system of fixed exchange rates, the fixed rates could be and often were changed. Therefore, system (i) would always carry some exchange rate uncertainty, whereas a monetary union with a single currency would not. d. All of the above. 83. The countries that belong to the EMU must abide by the Stability and Growth Pact (SGP) of This requires each country to keep its public-sector budget deficit under 3 percent of its GDP and its public-sector debt under 60 percent of its GDP. a. This restriction on a member nation s ability to use fiscal policy to stabilize its economy is not a big deal because monetary policy can be used by each country for that purpose. b. This restriction on a member nation s ability to use fiscal policy to stabilize its economy is potentially significant because nations that are in a monetary union do not have the ability to conduct their own monetary policy. c. The SGP makes it easier for EMU nations to cope with the problem of asymmetric shocks. d. The SGP makes the actual occurrence of asymmetric shocks more likely. 84. According to the theory of optimum currency areas, a monetary union is most appropriate between places that a. Are closely integrated through international trade and factor movements. b. Have weak or non-existent economic links, so that events in one country would have little or no effect on the other countries to which its currency is fixed. c. Have close political links. d. Aspire to peaceful relations but have a long history of mutual hostility. 85. According to this course s textbook, a. The Euro zone (i.e., the area under European Monetary Union) is an optimum currency area. b. Europe is probably not an optimum currency area. c. Europe is not an optimum currency area but will become one when it expands to include several countries in East Europe and, possibly, Turkey. d. None of the above. 86. What are the biggest advantages the U.S. has above the Euro zone in terms of being an Optimum 17

18 Currency Area? a. Low mobility of labor, higher labor productivity, lower level of intra-regional trade b. High unionization of U.S. Labor force c. I don t know d. High mobility of labor force, more fiscal transfer payments between regions e. Higher uniformity of population s taste in consumption 87. The birth of the Euro a. resulted in fixed exchange rates between all EMU member countries. b. resulted in flexible exchange rates between all EMU member countries. c. resulted in crawling-peg exchange rates between all EMU member countries. d. resulted in non currency board exchange rates between all EMU member countries. 88. Which of the following is true? a. All European countries are part of the EMU b. All Western European countries are part of the EMU c. Originally, 11 countries joined the EMU on January 1999 d. Not all Western European countries are part of the EMU 89. European countries were prompted to seek closer coordination of monetary policies and greater exchange rate stability in order to a. to enhance Europe s role in the world monetary system b. to turn the European Union into a truly unified market c. both to enhance Europe s role in the world monetary system and to turn the European Union into a truly unified market d. None of the above. e. both to turn the European Union into a truly unified market and to counter the rise of Japan in international financial markets 90. To join the Euro zone, a country must have a. a public-sector deficit no higher than 3 percent of its GDP in general. b. a public-sector deficit no higher than 2 percent of its GDP in general. c. a public-sector deficit no higher than 1 percent of its GDP in general. d. a zero public-sector deficit. 91. To join the Euro zone, a country must have a public debt below or approaching a reference level of a. 50 percent of its GDP. b. 10 percent of its GDP. c. 60 percent of its GDP. 18

19 d. 100 percent of its GDP. e. 5 percent of its GDP. 92. The efficiency a. gain from a fixed exchange rate with the euro is smaller when trade between say, Norway and the euro zone, is extensive than when it is small. b. gain from a fixed exchange rate with euro is greater when trade between say, Norway and the euro zone, is extensive than when it is small. c. loss from a fixed exchange rate with the euro is smaller when trade between say, Norway and the euro zone, is extensive than when it is small. d. gain from a fixed exchange rate with euro is the same as when trade between say, Norway and the euro zone, is extensive than when it is small. e. gain from a fixed exchange rate with euro is the same as when trade between say, Norway and the euro zone, is small than when it is small. 93. Which one of the following statements is true? a. The less extensive are cross-border trade and factor movements, the greater is the gain from a fixed cross-border exchange rate. b. The more extensive are cross-border trade and factor movements, the greater is the loss from a fixed cross-border exchange rate. c. The more extensive are cross-border trade and factor movements, the greater is the gain from a fixed cross-border exchange rate. d. The more extensive are cross-border trade, the greater is the loss from a fixed cross-border exchange rate. e. The more extensive are factor movements, the greater is the loss from a fixed cross-border exchange rate. 94. A country that joins an exchange rate area a. gives up its ability to use the exchange rate for the purpose of stabilizing output and employment. b. does not give up its ability to use the exchange rate and monetary policy for the purpose of stabilizing output and employment. c. gives up its ability to use the exchange rate and monetary policy for the purpose of stabilizing output and employment. d. gives up its ability to use only monetary policy for the purpose of stabilizing output and employment. e. does not gives up its ability to use only monetary policy for the purpose of stabilizing output and employment. 95. Which one of the following statements is true? a. A fixed exchange rate automatically cushions the economy s output and employment by allowing an immediate change in the relative price of domestic and foreign goods. b. A flexible exchange rate does not automatically cushions the economy s output and employment by allowing an immediate change in the relative price of domestic and foreign goods. 19

20 c. A flexible exchange rate automatically cushions the economy s output and employment by allowing an immediate change in the relative price of domestic and foreign goods. d. A flexible exchange rate automatically cushions the economy s output and employment by allowing an immediate change in the absolute price of domestic and foreign goods 96. Since Norway has close trading links with the euro zone, a. a small reduction in its overall price level will lead to an increase in euro zone demand for Norwegian goods that is large relative to Norway s output. Thus, full employment can be restored fairly quickly. b. a small reduction in its overall price level will lead to a decrease in euro zone demand for Norwegian goods that is large relative to Norway s output. Thus, full employment can be restored fairly quickly. c. a small reduction in its overall price level will lead to an increase in euro zone demand for Norwegian goods that is small relative to Norway s output. Thus, full employment can be restored fairly quickly. d. a big reduction in its overall price level will lead to an increase in euro zone demand for Norwegian goods that is large relative to Norway s output. Thus, full employment can be restored fairly quickly. 97. The intersection of GG and LL determines a. the optimal level of integration desired by Norway. b. the maximum integration level desired by Norway. c. the minimum level of integration that will cause Norway to join the fixed exchange rate regime. d. the maximum level of integration that will cause Norway to join the fixed exchange rare regime. 98. The level of fiscal federalism in the European Union is a. too big to cushion member countries from adverse economic events b. too small to cushion member countries from adverse economic events c. appropriate to cushion member countries from adverse economic events d. too big relative to the one in the U.S. e. similar in its level to that of the U.S. 99. A key barrier to labor mobility within Europe is a. the laziness of Germans b. full employment in most European countries c. differences in language and culture d. lack of transportation e. None of the above 100. Fiscal federalism in the Euro zone refers to 20

21 a. one nation s control of the monetary policy of all the other nations b. freedom of member countries to leave the EU at any time c. the transfer of economic resources from members with healthy economies to those suffering economic setbacks d. one nation s freedom to abandon the Euro and use its own currency e. None of the above 101. Which of the following is true about the future of the EU and its associated institutions? a. the lack of a strong EU political center may limit the ECB s political legitimacy in the eyes of the European public b. there is a danger that voters throughout Europe will come to view the ECB as a distant and politically unaccountable group of technocrats unresponsive to people s needs c. Asymmetric economic development within different countries of the euro zone will be hard to handle through monetary policy d. persistent barriers to labor mobility might continue to result in high levels of unemployment e. All of the above 102. The theory of optimum currency areas predicts that a. floating exchange rates are most appropriate for areas closely integrated through international trade and factor movements b. fixed exchange rates are most appropriate for areas that are loosely integrated through international trade and factor movements c. fixed exchange rates are most appropriate for areas closely integrated through international trade and factor movements d. floating exchange rates are most appropriate for all countries in Europe e. fixed exchange rates are most appropriate for all countries in Europe 103. The main function of the 1997 Stability and Growth Pact (SGP) was to a. distribute the Euro banknote among European central banks b. enhance cooperation between France and Germany c. create a timetable for the imposition of financial penalties on countries that fail to correct situations of excessive deficits and debt promptly enough d. (a) and (c) e. All of the above 21