978-0134472133 Test Bank Chapter 3 Part 2

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27) The biggest problem that China faces in maintaining a stable value for their currency, the

yuan, is their lack of foreign exchange reserves.

28) As of year-end 2010, the United States still held the world’s largest foreign exchange reserve,

but the total was rapidly being approached by China.

29) China’s current political plan includes reducing their foreign exchange reserve balance by

allowing the yuan to float freely and by switching their goods balance from one of a net surplus

30) An excess of merchandise exports over merchandise imports results in a balance of trade

31) The transition to floating exchange rate regimes in the 1970s (described in Chapter 3)

changed the focus from the total BOP to its various subaccount like the current and financial

32) What is a country’s balance of (merchandise) trade, and why is it so widely reported in the

33) What is the Official Reserves Account (ORA), and why is it more important for countries

under a fixed exchange rate regime than for ones under a floating exchange rate regime?

3.3 The BOP Impacts on Key Macroeconomic Rates

1) Under an international regime of fixed exchange rates, countries with a BOP ________ should

consider ________ their currency while countries with a BOP ________ should consider

________ their currency.

A) deficit, revaluing; surplus, revaluing

B) deficit, devaluing; surplus, devaluing

C) surplus, devaluing; deficit, revaluing

2) Use the following terms for this question:

C = consumption

I = capital investment spending

G = government spending

X = exports of goods and services

M = imports of goods and services

BOP = balance of payments

GDP = gross domestic product

NPV = net present value

INF = inflation

R = real rate of return

The static equation for the nations GDP is:

A) GDP = C + I + G + (X + M ) × INF

B) GDP = C + I + G + X + M

C) GDP = C + I + G + X – M

D) GDP = C + I + X – M + R

3) Use the following terms for this question:

(X-M) = Current Account Balance

(CI-CO) = Capital Account Balance

(FI-FO) = Financial Account Balance

(I-S) = Investment-Saving Balance

FXB = Reserve Balance

BOP = balance of payments

GDP = gross domestic product

C = consumption

I = capital investment spending

G = government spending

The static equation for the BOP is:

A) BOP = (X-M) – (CI-CO) – (FI-FO) + FXB

B) BOP = (X-M) + (I-S) + (FI-FO) + FXB

C) BOP = (X-M) + (CI-CO) + (FI-FO) + FXB

4) Imports have the potential to lower a country’s inflation rate because of each of the following

EXCEPT:

A) the import of lower priced goods limits what domestic competitors can charge for goods.

B) the import of lower priced services limits what domestic competitors can charge for services.

C) the higher prices of foreign goods spurs domestic competitors to cut prices.

D) all of the above

5) Under a fixed exchange rate system, the government bears the responsibility to ensure that the

BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the

government is expected to intervene in the foreign exchange market by buying or selling official

foreign exchange reserves. If the sum of the first two accounts is GREATER THAN ZERO, a

________ demand for the domestic currency exists in the world. To preserve the fixed exchange

rate, the government must then intervene in the foreign exchange market and ________ domestic

currency for foreign currencies or gold so as to bring the BOP back near zero.

A) surplus; sell

B) surplus; buy

C) deficit; sell

D) deficit; buy

6) Under a fixed exchange rate system, the government bears the responsibility to ensure that the

BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the

government is expected to intervene in the foreign exchange market by buying or selling official

foreign exchange reserves. If the sum of the first two accounts is LESS THAN ZERO, a

________ demand for the domestic currency exists in the world. To preserve the fixed exchange

rate, the government must then intervene in the foreign exchange market and ________ domestic

currency for foreign currencies or gold so as to bring the BOP back near zero.

A) surplus; sell

B) surplus; buy

C) deficit; sell

D) deficit; buy

7) An increase in GDP should lead to a decrease in imports.

Answer: FALSE

Explanation: An increase in GDP should lead to AN INCREASE in imports.

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Recognition

AACSB: Application of knowledge

8) The effect of an imbalance in the BOP is the same for countries on a fixed exchange rate

regime as for those on a floating exchange rate regime.

9) Under a floating exchange rate system, the government bears the responsibility to ensure that

the BOP is near zero.

10) A country with a managed float that wishes to WEAKEN its currency may choose to raise

11) A country’s overall level of interest rates should have an impact on the financial account of

the BOP. Relatively low real interest rates should normally stimulate an outflow of capital

12) Imports have the potential to lower a country’s inflation rate. In particular, imports of

HIGHER-priced goods and services place a limit on what domestic competitors charge for

comparable goods and services.

13) Very often governments seek to alter the market’s valuation of their currency by influencing

relative interest rates, thus influencing the economic fundamentals of exchange rate

determination rather than through direct intervention in the foreign exchange markets. Describe

how this strategy works. Describe the case of the U.S. or China where the opposite effect, to the

suggest here, have occurred.

3.4 Trade Balances and Exchange Rates

1) Of the following, which is NOT a part of J-Curve adjustment path?

A) the currency contract period

B) the exchange rate pass-through period

C) the quantity adjustment period

D) Each of the above is part of the J-Curve adjustment path.

2) Which of the following is NOT likely to occur in the quantity adjustment phase of the J-Curve

adjustment path?

A) Imports become relatively more expensive.

B) Exports become relatively less expensive.

C) The balance of trade gets worse.

D) All of the above are true.

3) When a currency is devalued the immediate impact may be an increase in a country’s trade

deficit. However, this situation tends to correct itself in 2 to 5 weeks.

4) The immediate impact of a devaluation of the domestic currency is to decrease the value of

5) Countries occasionally intentionally devalue their currencies. So what is the logic and likely

results of intentionally devaluing their domestic currency? International economic analysis

characterizes the trade balance adjustment process as occurring in three stages. List and explain

the three stages too.

3.5 Capital Mobility

1) The authors identify four distinct periods of capital mobility since 1860. Which do they term

as a “period of global economic destruction”?

A) 1860 – 1914

B) 1914 – 1945

C) 1945 – 1971

D) 1971 – 2007

2) ________ is the cross-border purchase of assets that are then managed in a way that hides the

movement of money and its ownership.

A) Capital flight

B) Capital mobility

C) Irrational exuberance

D) Money laundering

3) This was an era dominated by industrialized nation economies that were dependent on gold

convertibility to maintain confidence in the system.

A) The Gold Standard, 1860-1914

B) The Interwar Years , 1914-1945

C) The Bretton Woods Era, 1945-1971

D) The Floating Era, 1971-1997

4) This dollar-based fixed exchange rate system gave rise to a long period of economic recovery

and growing openness of both international trade and capital flows in and out of more and more

countries.

A) The Gold Standard, 1860-1914

B) The Interwar Years , 1914-1945

C) The Bretton Woods Era, 1945-1971

D) The Floating Era, 1971-1997

5) An era of retrenchment, in which major economic powers returned to policies of isolationism

and protectionism, restricting trade and nearly eliminating capital mobility.

A) The Gold Standard, 1860-1914

B) The Interwar Years , 1914-1945

C) The Bretton Woods Era, 1945-1971

D) The Floating Era, 1971-1997

6) A ________ is any restriction that limits or alters the rate or direction of capital movement

into or out of a country.

A) capital budget

B) capital control

C) balance of trade deficit

D) balance of trade surplus

7) Long-term capital flows reflect the following factors EXCEPT:

A) short term interest rate differentials

B) fundamental economic expectations

C) growth prospects

D) perceptions of political stability

8) Capital controls may take a variety of forms EXCEPT:

A) currency boards

B) taxes

C) quotas

D) prohibitions

9) The Bretton Woods era realized a great expansion of international trade in goods and services.

10) Longer-term capital flows reflect short-term interest rate differentials and exchange rate

expectations.

11) One of the motivations for capital controls is to insulate an economy from foreign political

risks.

12) Dutch Disease is a term applied to a problem in the 1970 whereby the Netherlands were

experiencing massive and sudden inflows of capital from abroad. What was the cause of this

sudden influx of capital, and what types of potential problems did it have for the Dutch or could

it have for any small single resource country?