A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal decline in its international reserves and the monetary base, everything else held constant.

1. A) sale; purchase
2. B) sale; sale
3. C) purchase; sale
4. D) purchase; purchase

Answer: C

A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal increase in its international reserves and the monetary base, everything else held constant.

1. A) sale; purchase
2. B) sale; sale
3. C) purchase; sale
4. D) purchase; purchase

Answer: A

Suppose that the Bank of Japan buys U.S. dollar assets with yen-denominated assets. Everything else held constant, this transaction will cause ________ in the foreign assets held by the Federal Reserve and ________ in the U.S. monetary base.

1. A) an increase; an increase
2. B) an increase; a decrease
3. C) a decrease; an increase
4. D) a decrease; a decrease

Answer: A

Suppose that the Bank of Japan buys yen-denominated assets with U.S. dollar assets. Everything else held constant, this transaction will cause ________ in the foreign assets held by the Federal Reserve and ________ in the U.S. monetary base.

1. A) an increase; an increase
2. B) an increase; a decrease
3. C) a decrease; an increase
4. D) a decrease; a decrease

Answer: D

When the central bank allows the purchase or sale of domestic currency to have an effect on the monetary base, it is called

1. A) an unsterilized foreign exchange intervention.
2. B) a sterilized foreign exchange intervention.
3. C) an exchange rate feedback rule.
4. D) a money neutral foreign exchange intervention.

Answer: A

A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called

1. A) an unsterilized foreign exchange intervention.
2. B) a sterilized foreign exchange intervention.
3. C) an exchange rate feedback rule.
4. D) a money neutral foreign exchange intervention.

Answer: B

Everything else held constant, if a central bank makes an unsterilized purchase of foreign assets, then the domestic money supply will ________ and the domestic currency will ________.

1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate

Answer: B

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will increase and the domestic currency will ________.

1. A) purchase; appreciate
2. B) purchase; depreciate
3. C) sale; appreciate
4. D) sale; depreciate

Answer: B

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will ________ and the domestic currency will appreciate.

1. A) purchase; increase
2. B) purchase; decrease
3. C) sale; increase
4. D) sale; decrease

Answer: D

Everything else held constant, if a central bank makes an unsterilized sale of foreign assets, then the domestic money supply will ________ and the domestic currency will ________.

1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate

Answer: C

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will decrease and the domestic currency will ________.

1. A) purchase; appreciate
2. B) purchase; depreciate
3. C) sale; appreciate
4. D) sale; depreciate

Answer: C

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will ________ and the domestic currency will depreciate.

1. A) purchase; increase
2. B) purchase; decrease
3. C) sale; increase
4. D) sale; decrease

Answer: A

Everything else held constant, if a central bank makes a sterilized purchase of foreign assets, then the domestic currency will

1. A) appreciate.
2. B) depreciate.
3. C) either appreciate, depreciate, or remain constant.
4. D) not be affected.

Answer: D

Because sterilized interventions mean offsetting open market operations, there is no impact on the monetary base and the money supply, and therefore a sterilized intervention

1. A) causes the exchange rate to overshoot in the short run.
2. B) causes the exchange rate to undershoot in the short run.
3. C) causes the exchange rate to depreciate in the short run, but has no effect on the exchange rate in the long run.
4. D) has no effect on the exchange rate.

Answer: D

Everything else held constant, if a central bank makes a sterilized sale of foreign assets, then the domestic currency will

1. A) appreciate.
2. B) depreciate.
3. C) either appreciate, depreciate, or remain constant.
4. D) not be affected.

Answer: D

If the United States has a current account deficit with England of $1 million, and the Bank of England sells $1 million worth of pounds in the foreign exchange market, then England ________ $1 million of international reserves and its monetary base ________ by $1 million.

1. A) gains; rises
2. B) gains; falls
3. C) loses; rises
4. D) loses; falls

Answer: A

The difference between merchandise exports and imports is called the ________ balance.

1. A) current account
2. B) capital account
3. C) official reserve transactions
4. D) trade

Answer: D

The account that shows international transactions involving currently produced goods and services is called the

1. A) trade balance.
2. B) current account.
3. C) balance of payments.
4. D) capital account.

Answer: B

The account that shows international transactions involving financial transactions (stocks, bonds, bank loans, etc.) is called the

1. A) trade balance.
2. B) current account.
3. C) balance of payments.
4. D) capital account.

Answer: D

Which of the following does NOT appear in the current account part of the balance of payments?

1. A) a loan of $1 million from Bank of America to Brazil
2. B) foreign aid to El Salvador
3. C) an Air France ticket bought by an American
4. D) income earned by General Motors from its plants abroad

Answer: A

Of the following, the one that appears in the current account of the balance of payments is

1. A) an Italian investor's purchase of IBM stock.
2. B) income earned by U.S. subsidiaries of Barclay's Bank of London.
3. C) a loan by a Swiss bank to an American corporation.
4. D) a purchase of a British Treasury bond by the Fed.

Answer: B

Capital ________ are American purchases of foreign assets, and capital ________ are foreign purchases of American assets.

1. A) inflows; outflows
2. B) inflows; inflows
3. C) outflows; outflows
4. D) outflows; inflows

Answer: D

Which of the following appears in the capital account part of the balance of payments?

1. A) a gift to an American from his English aunt
2. B) a purchase by the Honda corporation of a U.S. Treasury bill
3. C) a purchase by the Bank of England of a U.S. Treasury bill
4. D) income earned by the Honda corporation on its automobile plant in Ohio

Answer: B

The net amount of international reserves that move between governments to finance international transactions is called the ________ balance.

1. A) capital account
2. B) current account
3. C) trade
4. D) official reserve transactions

Answer: D

If the current account balance shows a surplus, and the capital account also shows a surplus, then the official reserve transactions balance

1. A) must be positive.
2. B) must be negative.
3. C) must be zero.
4. D) can either be positive, negative, or zero.

Answer: A

A current account surplus indicates that America is ________ its claims on foreign wealth, while a deficit indicates that this country is ________ its claims on foreign wealth.

1. A) reducing; reducing
2. B) reducing; increasing
3. C) increasing; reducing
4. D) increasing; increasing

Answer: C

Because it provides some indication of what is happening to U.S. claims on foreign wealth and the demand for imports and exports, the ________ is closely followed by economists wanting information on the future movement of exchange rates.

1. A) trade balance
2. B) capital account
3. C) current account balance
4. D) statistical discrepancy

Answer: C

Economists closely follow the current account balance because they believe it can provide information on the future movement of

1. A) interest rates.
2. B) gold flows.
3. C) exchange rates.
4. D) special drawing rights.

Answer: C

Under a gold standard in which one dollar could be turned in to the U.S. Treasury and exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for 1/100th of an ounce of gold, an exchange rate of ________ marks to the dollar would stimulate a flow of gold from the United States to Germany.

1. A) 7
2. B) 6
3. C) 5
4. D) 4

Answer: D

When gold production was low in the 1870s and 1880s, the money supply grew ________ causing ________.

1. A) rapidly; inflation
2. B) rapidly; disinflation
3. C) slowly; deflation
4. D) slowly; disinflation

Answer: C

The fixed exchange rate regime established at a meeting in New Hampshire in 1944 has been known as the

1. A) General Agreement on Tariffs and Trade.
2. B) Bretton Woods system.
3. C) International Settlement Fund.
4. D) Balance of Payments Compliance Accord.

Answer: B

Under the Bretton Woods system, the organization assigned the task of making loans to countries that were experiencing balance of payments difficulties is known as the

1. A) World Bank.
2. B) International Development Association.
3. C) International Monetary Fund.
4. D) Federal Reserve System.

Answer: C

The Bretton Woods agreement created the ________, which was given the task of promoting the growth of world trade by setting rules for the maintenance of fixed exchange rates and by making loans to countries that were experiencing balance of payments difficulties.

1. A) IMF
2. B) World Bank
3. C) Central Settlements Bank
4. D) Bank of International Settlements

Answer: A

The World Bank is an international organization that

1. A) promotes the growth of trade by setting rules for how tariffs and quotas are set by countries.
2. B) makes loans to countries to finance projects such as dams and roads.
3. C) makes loans to countries with balance of payment difficulties.
4. D) helps developing countries that have been having difficulties in repaying their loans to come to terms with lenders in the West.

Answer: B

Under the Bretton Woods system, the United States was designated as the

1. A) reserve-currency country.
2. B) fixed-rate country.
3. C) par-standard country.
4. D) dollar-standard country.

Answer: A

Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________ par, the central bank must intervene to sell the domestic currency by purchasing foreign assets.

1. A) overvalued; below
2. B) overvalued; above
3. C) undervalued; below
4. D) undervalued; above

Answer: D

Under a fixed exchange rate regime, if the domestic currency is initially undervalued, that is, above par, the central bank must intervene to sell the ________ currency by purchasing ________ assets.

1. A) domestic; foreign
2. B) domestic; domestic
3. C) foreign; foreign
4. D) foreign; domestic

Answer: A

Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________ par, the central bank must intervene to purchase the domestic currency by selling foreign assets.

1. A) overvalued; below
2. B) overvalued; above
3. C) undervalued; below
4. D) undervalued; above

Answer: A

Under a fixed exchange rate regime, if the domestic currency is initially overvalued, that is, below par, the central bank must intervene to purchase the ________ currency by selling ________ assets.

1. A) domestic; foreign
2. B) domestic; domestic
3. C) foreign; foreign
4. D) foreign; domestic

Answer: A

Under a fixed exchange rate regime, if a central bank must intervene to purchase the ________ currency by selling ________ assets, then, like an open market sale, this action reduces the monetary base and the money supply, causing the interest rate on domestic assets to rise.

1. A) domestic; foreign
2. B) domestic; domestic
3. C) foreign; foreign
4. D) foreign; domestic

Answer: A

Under a fixed exchange rate regime, if a central bank must intervene to purchase the domestic currency by selling foreign assets, then, like an open market sale, this action ________ the monetary base and the money supply, causing the interest rate on domestic assets to ________.

1. A) increases; rise
2. B) increases; fall
3. C) reduces; rise
4. D) reduces; fall

Answer: C

When the domestic currency is initially overvalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

1. A) purchase; decline
2. B) sell; decline
3. C) purchase; increase
4. D) sell; increase

Answer: A

When the domestic currency is initially undervalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

1. A) purchase; decline
2. B) sell; decline
3. C) purchase; increase
4. D) sell; increase

Answer: D

Under a fixed exchange rate regime, if a country has an overvalued exchange rate, then its central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.

1. A) depreciating; gain
2. B) depreciating; loss
3. C) appreciating; gain
4. D) appreciating; loss

Answer: B

Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central bank's attempt to keep its currency from depreciating will result in a ________ of international reserves.

1. A) undervalued; gain
2. B) undervalued; loss
3. C) overvalued; gain
4. D) overvalued; loss

Answer: D

Under a fixed exchange rate regime, if a country has an undervalued exchange rate, then its central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.

1. A) depreciating; gain
2. B) depreciating; loss
3. C) appreciating; gain
4. D) appreciating; loss

Answer: C

Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central bank's attempt to keep its currency from appreciating will result in a ________ of international reserves.

1. A) undervalued; gain
2. B) undervalued; loss
3. C) overvalued; gain
4. D) overvalued; loss

Answer: A

Under a fixed exchange rate regime, if a country's central bank runs out of international reserves, it cannot keep its currency from

1. A) depreciating.
2. B) appreciating.
3. C) deflating.
4. D) inflating.

Answer: A

Under a fixed exchange rate regime, a country that depletes its international reserves in an attempt to keep its currency from ________ will be forced to ________ its currency.

1. A) depreciating; revalue
2. B) depreciating; devalue
3. C) appreciating; revalue
4. D) appreciating; devalue

Answer: B

Under a fixed exchange rate regime, a central bank that does not want to acquire international reserves to keep its currency from ________ will decide to ________ its currency.

1. A) depreciating; revalue
2. B) depreciating; devalue
3. C) appreciating; revalue
4. D) appreciating; devalue

Answer: C

A balance of payments deficit is associated with a ________ of international reserves, while a balance of payments surplus is associated with a ________.

1. A) loss; loss
2. B) loss; gain
3. C) gain; loss
4. D) gain; gain

Answer: B

Because central banks have not been willing to give up their option of intervening in the foreign exchange market, the current international financial system can best be described as a

1. A) variable-pegged exchange rate system.
2. B) moving-pegged exchange rate system.
3. C) hybrid of a fixed exchange rate and flexible exchange rate system.
4. D) flexible-exchange, dollar-pegged exchange rate system.

Answer: C

The current international financial system is a managed float exchange rate system because

1. A) exchange rates fluctuate in response to, but are not determined solely by, market forces.
2. B) some countries keep their currencies pegged to the dollar, which is not allowed to fluctuate.
3. C) all countries allow their exchange rates to fluctuate in response to market forces.
4. D) all countries peg their currencies to the dollar which is allowed to fluctuate in response to market forces.

Answer: A

Policymakers in a country with a balance of payments surplus may not want to see their country's currency appreciate because this would

1. A) hurt consumers in their country by making foreign goods more expensive.
2. B) hurt domestic businesses by making foreign goods cheaper in their country.
3. C) increase inflation in their country.
4. D) decrease the wealth of the country.

Answer: B

Under the current managed float exchange rate regime, countries with balance of payments deficits frequently do not want to see their currencies depreciate because it makes ________ goods more expensive for ________ consumers and can stimulate inflation.

1. A) foreign; foreign
2. B) foreign; domestic
3. C) domestic; foreign
4. D) domestic; domestic

Answer: B

Countries with surpluses in their balance of payments frequently do not want to see their currencies ________ because it makes their goods ________ expensive abroad.

1. A) appreciate; less
2. B) appreciate; more
3. C) depreciate; less
4. D) depreciate; more

Answer: B

Countries with balance of payments deficits do not want to see their currencies ________ because it makes foreign goods ________ expensive for domestic consumers.

1. A) appreciate; less
2. B) appreciate; more
3. C) depreciate; less
4. D) depreciate; more

Answer: D

Under the current managed float exchange rate regime, countries with ________ in their balance of payments frequently do not want to see their currencies ________ because it makes their goods more expensive abroad and foreign goods cheaper in their countries.

1. A) surpluses; depreciate
2. B) deficits; depreciate
3. C) surpluses; appreciate
4. D) deficits; appreciate

Answer: C

Under the current managed float exchange rate regime; countries with surpluses in their balance of payments frequently do not want to see their currencies appreciate because it makes their goods ________ expensive abroad and foreign goods ________ in their countries.

1. A) more; cheaper
2. B) more; costlier
3. C) less; cheaper
4. D) less; costlier

Answer: A

Under the current managed float exchange rate regime, countries with balance of payments ________ frequently do not want to see their currencies ________ because it makes foreign goods more expensive for domestic consumers and can stimulate inflation.

1. A) surpluses; depreciate
2. B) deficits; depreciate
3. C) surpluses; appreciate
4. D) deficits; appreciate

Answer: B

A speculative attack involves massive sales of a currency or purchases of a currency that cause a sharp change in the exchange rate under a exchange rate system.

1. A) weak; strong; fixed
2. B) strong; weak; fixed
3. C) weak; strong; floating
4. D) strong; weak; floating

Answer: A

Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing

Answer: A

Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the German central bank was required to buy ________ and sell ________, thereby ________ international reserves.

1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing

Answer: B

Under the Exchange Rate Mechanism of the European Monetary System, when the German mark depreciated below its lower limit against the British pound, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing

Answer: C

Under the Exchange Rate Mechanism of the European Monetary System, when the German mark depreciated below its lower limit against the British pound, the German central bank was required to buy ________ and sell ________, thereby ________ international reserves.

1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing

Answer: D

In September 1992, the Bundesbank attempted to keep the mark from appreciating relative to the British pound, but it failed because participants in the foreign exchange market came to expect the

1. A) appreciation of the mark.
2. B) depreciation of the mark.
3. C) revaluation of the dollar.
4. D) end of the Exchange Rate Mechanism.

Answer: A

The Policy Trilemma states that a country or a monetary union can't pursue the following three policies at the same time

1. A) capital control, a fixed exchange rate, and an independent monetary policy.
2. B) free capital mobility, a fixed exchange rate, and an independent monetary policy.
3. C) free capital mobility, a flexible exchange rate, and an independent monetary policy.
4. D) capital control, a flexible exchange rate, and an independent monetary policy.

Answer: B

China chooses to have ________ and ________ and therefore, cannot have free capital mobility at the same time.

1. A) a fixed exchange rate; no control of monetary policy
2. B) a fixed exchange rate; an independent monetary policy
3. C) a flexible exchange rate; an independent monetary policy
4. D) a flexible exchange rate; no control of monetary policy

Answer: B

The United States chooses to have ________ and ________ and therefore, cannot have a fixed exchange rate at the same time.

1. A) capital control; an independent monetary policy
2. B) free capital mobility; an independent monetary policy
3. C) free capital mobility; no control of monetary policy
4. D) capital control; no control of monetary policy

Answer: B

Hong Kong chooses to have ________ and ________ and therefore, cannot have an independent monetary policy at the same time.

1. A) capital control; a fixed exchange rate
2. B) free capital mobility; a fixed exchange rate
3. C) free capital mobility; a flexible exchange rate
4. D) capital control; a flexible exchange rate

Answer: B

Explain and demonstrate graphically the situation of an overvalued exchange rate in a fixed exchange rate system. What alternative policies are available to eliminate the overvaluation of the exchange rate?

Answer: See Chapt. 18 number 71

The par value is above the equilibrium value, resulting in overvaluation of the exchange rate. One approach is to pursue contractionary monetary policies, raising interest rates and increasing the demand for domestic assets. This process continues until equilibrium at par value is restored. Another alternative is for the central bank to purchase domestic currency by selling foreign assets.

Assume that a fixed exchange rate is overvalued. Describe the situation of a speculative crisis against this currency. What can the central bank do to defend the currency? Why might the alternative of devaluation be preferable?

Answer: When the speculative attack begins, the expected depreciation of the domestic currency increases substantially, decreasing the demand for domestic assets. Contractionary monetary policy is needed to increase domestic interest rates enough to defend the currency. The cost to the central bank in terms of the costs of intervention and the contractionary effect on the economy may make devaluation preferable.

A capital ________ can promote financial instability in an emerging-market country because it is what forces a country to ________ its currency.

1. A) inflow; devalue
2. B) inflow; revalue
3. C) outflow; devalue
4. D) outflow; revalue

Answer: C

A capital ________ can promote financial instability in an emerging-market country because it can lead to a lending boom and excessive risk-taking on the part of banks, which helps trigger a ________.

1. A) inflow; financial crisis
2. B) inflow; currency devaluation
3. C) outflow; financial crisis
4. D) outflow; currency devaluation

Answer: A

A case for capital inflow controls can be made because capital inflows

1. A) can cause a lending boom and lead to excessive risk taking.
2. B) never finance productive investments.
3. C) always finance productive investments.
4. D) are less likely to cause financial crises than regulation of banking activities.

Answer: A

Which of the following is NOT a disadvantage of controls on capital outflows?

1. A) The controls may lead to excessive risk taking by the domestic banks.
2. B) They are seldom effective during a crisis.
3. C) Capital flight may increase after they are put in place.
4. D) Controls often lead to an increase in government corruption.

Answer: A

This agency acts like an international lender of last resort to cope with financial instability.

1. A) World Bank
2. B) European Central Bank
3. C) IMF
4. D) International Bank for Reconstruction and Development

Answer: C

An international lender of last resort creates a serious ________ problem because depositors and other creditors of banking institutions expect that they will be protected if a crisis occurs.

1. A) moral hazard
2. B) adverse selection
3. C) public choice
4. D) strategic choice

Answer: A

An international lender of last resort creates a serious moral hazard problem because ________ and other ________ of banking institutions expect that they will be protected if a crisis occurs.

1. A) depositors; debtors
2. B) depositors; creditors
3. C) borrowers; debtors
4. D) borrowers; creditors

Answer: B

In the early 1970s, the U.S. ran large balance of payments ________, causing an ________ dollar and an ________ German mark.

1. A) deficits; undervalued; overvalued
2. B) deficits; overvalued; undervalued
3. C) surpluses; undervalued; overvalued
4. D) surpluses; overvalued; undervalued

Answer: B

In response to the overvalued dollar in the early 1970s, the German Bundesbank bought ________ and sold ________ to keep the exchange rate fixed, gaining international reserves.

1. A) marks; dollars
2. B) marks; pounds
3. C) dollars; marks
4. D) dollars; pounds

Answer: C

In response to the overvalued dollar in the early 1970s, the German Bundesbank bought dollars and sold marks to keep the exchange rate fixed, gaining international reserves. The huge purchase of international reserves meant that the German monetary base began to ________, leading to ________ growth in the German money supply.

1. A) decline; sluggish
2. B) decline; rapid
3. C) grow; sluggish
4. D) grow; rapid

Answer: D

The German central bank gained international reserves in the early 1970s because it sold ________ to prevent mark ________.

1. A) marks; appreciation
2. B) dollars; appreciation
3. C) marks; depreciation
4. D) dollars; depreciation

Answer: A

Since the abandonment of the Bretton Woods system, balance of payments considerations have become ________ important, and exchange rate considerations ________ important in the conduct of monetary policy.

1. A) more; less
2. B) more; more
3. C) less; less
4. D) less; more

Answer: D

If a central bank does not want to see its currency fall in value, it may pursue ________ monetary policy to ________ the domestic interest rate, thereby strengthening its currency.

1. A) expansionary; raise
2. B) contractionary; raise
3. C) expansionary; lower
4. D) contractionary; lower

Answer: B

If a central bank does not want to see its currency ________ in value, it may pursue contractionary monetary policy to raise the domestic interest rate, thereby ________ its currency.

1. A) fall; strengthening
2. B) fall; weakening
3. C) rise; strengthening
4. D) rise; weakening

Answer: A

If a central bank does not want to see its currency rise in value, it may pursue ________ monetary policy to ________ the domestic interest rate, thereby weakening its currency.

1. A) expansionary; raise
2. B) contractionary; raise
3. C) expansionary; lower
4. D) contractionary; lower

Answer: C

If a central bank does not want to see its currency ________ in value, it may pursue expansionary monetary policy to lower the domestic interest rate, thereby ________ its currency.

1. A) fall; strengthening
2. B) fall; weakening
3. C) rise; strengthening
4. D) rise; weakening

Answer: D

If a central bank does not want to allow the domestic currency to appreciate, it will ________ international reserves by selling its currency, thereby ________ the monetary base and increasing the risk of higher inflation.

1. A) lose; decreasing
2. B) lose; increasing
3. C) acquire; decreasing
4. D) acquire; increasing

Answer: D

If a central bank does not want to allow the domestic currency to depreciate, it will ________ international reserves by purchasing its currency, thereby ________ the monetary base and increasing the risk of higher unemployment.

1. A) lose; decreasing
2. B) lose; increasing
3. C) acquire; decreasing
4. D) acquire; increasing

Answer: A

A central bank's attempt to prevent an appreciation of its currency can stimulate domestic inflation if the ________ of its currency leads to ________ international reserves which ________ the monetary base.

1. A) purchase; higher; increases
2. B) purchase; lower; decreases
3. C) sale; lower; decreases
4. D) sale; higher; increases

Answer: D

A central bank's attempt to prevent an appreciation of its currency can stimulate domestic inflation if the ________ of foreign currencies leads to ________ international reserves which ________ the monetary base.

1. A) purchase; higher; increases
2. B) purchase; lower; decreases
3. C) sale; lower; decreases
4. D) sale; higher; increases

Answer: A

To keep from running out of international reserves under the Bretton Woods system, a country had to implement ________ monetary policy to ________ its currency.

1. A) expansionary; strengthen
2. B) expansionary; weaken
3. C) contractionary; strengthen
4. D) contractionary; weaken

Answer: C

Under the Bretton Woods system, when a country adopted an expansionary monetary policy, thereby causing a balance of payments ________, the country would eventually be forced to implement ________ monetary policy.

1. A) deficit; expansionary
2. B) deficit; contractionary
3. C) surplus; expansionary
4. D) surplus; contractionary

Answer: B

Because the United States was the reserve-currency country under the Bretton Woods system, it could run large balance of payments ________ without ________ significant amounts of international reserves.

1. A) deficits; losing
2. B) deficits; gaining
3. C) surpluses; losing
4. D) surpluses; gaining

Answer: A

A monetary policy strategy that uses a fixed exchange rate regime that ties the value of a currency to the currency of a large, low inflation country is called ________ targeting.

1. A) exchange-rate
2. B) currency
3. C) monetary
4. D) inflation

Answer: A

Under an exchange-rate targeting rule for monetary policy, a crawling peg

1. A) fixes the value of the domestic currency to a commodity such as gold.
2. B) fixes the value of the domestic currency to that of a large, low-inflation country.
3. C) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be higher than that of the anchor country.
4. D) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be lower than that of the anchor country.

Answer: C

An advantage to exchange-rate targeting is it helps keep inflation under control by tying the inflation rate for ________ traded goods to what is found in the ________ country.

1. A) domestically; anchor
2. B) domestically, domestic
3. C) internationally; anchor
4. D) internationally; domestic

Answer: C

Exchange-rate targeting allows a central bank to ________, thus this will ________ the probability of policy developing a time-inconsistency problem.

1. A) be governed by a policy rule; decrease
2. B) follow discretionary policy; decrease
3. C) be governed by a policy rule; increase
4. D) follow discretionary policy; increase

Answer: A

Which of the following is NOT an advantage to exchange-rate targeting?

1. A) It provides a strong nominal anchor to keep inflation under control.
2. B) It provides an automatic rule for policy to help avoid the time-inconsistency problem.
3. C) It is simple and clear so that the public can easily understand it.
4. D) It increases the accountability of policymakers.

Answer: D

Under exchange-rate targeting, the central bank in the targeting country ________ lose the ability to pursue its own independent monetary policy and any shocks to the anchor country is ________ transmitted to the targeting country.

1. A) does; directly
2. B) does not; directly
3. C) does; not directly
4. D) does not; not directly

Answer: A

Both France and the United Kingdom successfully used exchange-rate targeting to lower inflation in the late 1980s and early 1990s by tying the value of their currencies to the

1. A) U.S. dollar.
2. B) German mark.
3. C) Swiss franc.
4. D) Euro.

Answer: B

Which of the following is NOT a disadvantage of exchange-rate targeting?

1. A) It relies on a stable money-inflation relationship.
2. B) The targeting country gives up an independent monetary policy.
3. C) The targeting country is left open for a speculative attack.
4. D) It can weaken the accountability of policymakers.

Answer: A

Two reasons for an industrialized country to adopt an exchange-rate targeting regime are if the country ________ conduct successful monetary policy on its own, and if the country wants to ________ integration of the domestic economy with its neighbors.

1. A) cannot; encourage
2. B) cannot; discourage
3. C) can; encourage
4. D) can; discourage

Answer: A

An emerging market country that successfully used exchange-rate targeting to lower its inflation from above 100 percent in 1988 to below 10 percent in 1994 (before devaluation) was

1. A) Thailand.
2. B) Mexico.
3. C) The Philippines.
4. D) Indonesia.

Answer: B

Because many emerging market countries have not developed the political or monetary institutions that allow the successful use of discretionary monetary policy

1. A) they have little to gain from pegging their exchange rate to an anchor country like the U.S. or Germany.
2. B) they have little to gain from using a nominal anchor, because it would mean a monetary policy that is overly expansionary.
3. C) they have very little to gain from an independent monetary policy, but a lot to lose.
4. D) they would be better off giving their central bankers the independence to use discretion, rather than take their discretion away through any nominal anchor.

Answer: C

When a domestic currency is completely backed by a foreign currency and the note-issuing authority establishes a fixed exchange rate to this foreign currency, then the country is said to have

1. A) created a currency board.
2. B) undergone dollarization.
3. C) adopted a managed exchange system.
4. D) adopted an exchange rate monetary system.

Answer: A

When a country forgoes its own currency and starts using another country's currency as its own, we say that this country has

1. A) created a currency board.
2. B) undergone dollarization.
3. C) adopted a managed exchange system.
4. D) adopted an exchange rate monetary system.

Answer: B

The revenue a government gains from issuing money is

1. A) interest.
2. B) rent.
3. C) seignorage.
4. D) the national dividend.
5. E) the inflation tax.

Answer: C

A country that dollarizes

1. A) maximizes its seignorage.
2. B) earns the same amount of seignorage as it would with a currency board.
3. C) earns the same amount of seignorage as it would with exchange-rate targeting.
4. D) eliminates its seignorage.
5. E) must pay seignorage to other governments to use their currency.

Answer: D

The seignorage for a government is greater for ________ than for ________.

1. A) dollarization; a currency board
2. B) dollarization; exchange-rate targeting
3. C) dollarization; monetary targeting
4. D) dollarization; inflation targeting
5. E) exchange-rate targeting; dollarization

Answer: E

The monetary policy strategy that provides an automatic rule for the conduct of monetary policy is

1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.

Answer: A

The monetary policy strategy that does NOT allow the policy to focus on domestic considerations is

1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.

Answer: A

The monetary policy strategy that results in the loss of an independent monetary policy is

1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.

Answer: A

The monetary policy strategy that directly ties down the price of internationally traded goods is

1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.

Answer: A

Explain an additional disadvantage for a country undergoing dollarization compared to a currency board or other exchange-rate targeting regimes.

Answer: The additional disadvantage to dollarization is that the government loses seignorage. Seignorage is the income that a government earns by issuing its own currency.

Explain the 1992 crisis that led to the breakdown of the European Union's Exchange Rate Mechanism. What disadvantages of exchange-rate targeting were exhibited during this crisis?

Answer: The 1992 crisis began with Germany raising interest rates in 1990 to stem inflationary pressures from reunification. This demand shock was immediately transmitted to the other nations in the exchange-rate mechanism. Thus, these countries did not have independent monetary policies and were subject to shocks from the anchor country. This gave rise to the second problem. Speculators bet that these other countries would not want the increased unemployment resulting from the tight monetary policy. Betting that their commitment was weak, speculators bet against these currencies, and a number were forced to devalue or drop out of the ERM. The disadvantages illustrated by this are the lack of independent policy subjecting member nations to shocks from the anchor nation, and the possibility of speculative attacks when commitment is felt to be weak.