PRACTICE QUESTIONS ON CHAPTER 20 ECO41 FALL 2014 UDAYAN ROY These questions may help you prepare for the upcoming final test at 8:00 am on Wednesday, December 17. CHAPTER 20 Optimum Currency Areas and the European Experience 1. 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. 2. 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 (which are economic shocks that do not affect all states in the same way), and the volume of trade between the states would. a. better; increase b. less; increase c. less; decrease d. better; decrease 3. 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: If 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, then the authorities that control the quantity of money would find it impossible to satisfy every region. a. An increase; an increase b. An increase; a decrease c. A decrease; a decrease d. A decrease; a decrease 4. 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 would be largely synchronized (i.e., when one country has high unemployment so would the others and when one country has high inflation so would 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.
d. All of the above. 5. 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 eleven European countries to form a monetary union in 1999 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. 6. The countries that belong to the EMU must abide by the Stability and Growth Pact (SGP) of 1997. 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. 7. 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. 8. 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. 9. What are the biggest advantages the U.S. has above the Euro zone in terms of being an Optimum 2
Currency Area? a. Lower mobility of labor, higher labor productivity, lower level of intra-regional trade in the US b. High unionization rate of U.S. Labor force c. Higher mobility of labor force, more fiscal transfer payments between regions through a unified federal budget d. Higher uniformity of population s taste in consumption e. None of the above; the US has no advantages over the Eurozone in terms of being an optimum currency area 10. 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. 11. European countries wanted to seek closer coordination of their monetary policies and greater exchange rate stability 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 12. 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. 13. 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. d. 100 percent of its GDP. e. 5 percent of its GDP. 14. Denmark maintains a fixed exchange rate of its currency with respect to the Euro. Which one of the following statements is true? 3
a. The less extensive are cross-border trade and factor movements, the greater is the efficiency gain from a fixed cross-border exchange rate. b. The more extensive are cross-border trade and factor movements, the greater is the efficiency loss from a fixed cross-border exchange rate. c. The more extensive are cross-border trade and factor movements, the greater is the efficiency 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. 15. A country that joins a common currency area a. does not give up its ability to rely on automatic changes in the exchange rate and monetary policy for the purpose of stabilizing output and employment. b. does not gives up its ability to rely on monetary policy for the purpose of stabilizing output and employment. c. gives up its ability to rely on automatic changes in the exchange rate for the purpose of stabilizing output and employment. d. gives up its ability to rely on automatic changes in the exchange rate and monetary policy for the purpose of stabilizing output and employment. e. gives up its ability to rely on monetary policy for the purpose of stabilizing output and employment. 16. 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. 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 17. Suppose Norway suffers a recession caused by a decline in the overall demand for Norwegian goods. Since Norway has close trading links with the euro zone, a. a small reduction in its overall price level or in the exchange value of its currency 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 or in the exchange value of its currency will lead to a decrease in euro zone demand for Norwegian goods that is large relative to Norway s output. Thus, full employment cannot be restored fairly quickly. c. a small reduction in its overall price level or in the exchange value of its currency 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. 4
d. None of the above. 18. Suppose Norway is considering whether to join the euro zone. In the formal theory of optimum currency areas, Norway s GG curve shows how its efficiency gains from joining the euro zone increases with the level of Norway s economic integration with the countries of the euro zone, and Norway s LL curve shows how its stability losses from joining the euro zone decreases with the level of Norway s economic integration with the countries of the euro zone. The intersection of the GG and LL curves 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. 19. The level of fiscal federalism in the European Monetary 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. 20. 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 21. Fiscal federalism in the Euro zone refers to a. one nation s control of the monetary policy of all the other nations b. freedom of member countries to leave the euro zone at any time c. the transfer of economic resources from members with healthy economies to those suffering economic setbacks through the operation of a unified euro zone budget d. one nation s freedom to abandon the Euro and use its own currency e. None of the above 22. Which of the following is true about the future of the euro zone and its associated institutions? a. the lack of a strong euro zone political center may limit the European Central Bank s political legitimacy in the eyes of the European public b. there is a danger that voters throughout euro zone 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 5
d. persistent barriers to labor mobility might continue to result in high levels of unemployment e. All of the above 6