35) 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.
A) pounds; marks; losing
B) pounds; marks; gaining
C) marks; pounds; gaining
D) marks; pounds; losing
36) 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.
A) pounds; marks; losing
B) pounds; marks; gaining
C) marks; pounds; gaining
D) marks; pounds; losing
37) 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.
A) pounds; marks; losing
B) pounds; marks; gaining
C) marks; pounds; gaining
D) marks; pounds; losing
38) 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
A) appreciation of the mark.
B) depreciation of the mark.
C) revaluation of the dollar.
D) end of the Exchange Rate Mechanism.
39) The Policy Trilemma states that a country or a monetary union can’t pursue the following
three policies at the same time
A) capital control, a fixed exchange rate, and an independent monetary policy.
B) free capital mobility, a fixed exchange rate, and an independent monetary policy.
C) free capital mobility, a flexible exchange rate, and an independent monetary policy.
D) capital control, a flexible exchange rate, and an independent monetary policy.
40) From 1994 to 2005, China chose to have ________ and ________ and therefore, could not
have free capital mobility at the same time.
A) a fixed exchange rate; no control of monetary policy
B) a fixed exchange rate; an independent monetary policy
C) a flexible exchange rate; an independent monetary policy
D) a flexible exchange rate; no control of monetary policy
41) The United States chooses to have ________ and ________ and therefore, cannot have a
fixed exchange rate at the same time.
A) capital control; an independent monetary policy
B) free capital mobility; an independent monetary policy
C) free capital mobility; no control of monetary policy
D) capital control; no control of monetary policy
42) Hong Kong chooses to have ________ and ________ and therefore, cannot have an
independent monetary policy at the same time.
A) capital control; a fixed exchange rate
B) free capital mobility; a fixed exchange rate
C) free capital mobility; a flexible exchange rate
D) capital control; a flexible exchange rate
43) 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?
44) 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?
18.4 Capital Controls
1) A capital ________ can promote financial instability in an emerging-market country because
it is what forces a country to ________ its currency.
A) inflow; devalue
B) inflow; revalue
C) outflow; devalue
D) outflow; revalue
2) 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 ________.
A) inflow; financial crisis
B) inflow; currency devaluation
C) outflow; financial crisis
D) outflow; currency devaluation
3) A case for capital inflow controls can be made because capital inflows
A) can cause a lending boom and lead to excessive risk taking.
B) never finance productive investments.
C) always finance productive investments.
D) are less likely to cause financial crises than regulation of banking activities.
4) Which of the following is NOT a disadvantage of controls on capital outflows?
A) The controls may lead to excessive risk taking by the domestic banks.
B) They are seldom effective during a crisis.
C) Capital flight may increase after they are put in place.
D) Controls often lead to an increase in government corruption.
18.5 The Role of the IMF
1) This agency acts like an international lender of last resort to cope with financial instability.
A) World Bank
B) European Central Bank
C) IMF
D) International Bank for Reconstruction and Development
2) 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.
A) moral hazard
B) adverse selection
C) public choice
D) strategic choice
3) 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.
A) depositors; debtors
B) depositors; creditors
C) borrowers; debtors
D) borrowers; creditors
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18.6 International Considerations and Monetary Policy
1) In the early 1970s, the U.S. ran large balance of payments ________, causing an ________
dollar and an ________ German mark.
A) deficits; undervalued; overvalued
B) deficits; overvalued; undervalued
C) surpluses; undervalued; overvalued
D) surpluses; overvalued; undervalued
2) 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.
A) marks; dollars
B) marks; pounds
C) dollars; marks
D) dollars; pounds
3) 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.
A) decline; sluggish
B) decline; rapid
C) grow; sluggish
D) grow; rapid
4) The German central bank gained international reserves in the early 1970s because it sold
________ to prevent mark ________.
A) marks; appreciation
B) dollars; appreciation
C) marks; depreciation
D) dollars; depreciation
5) 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.
A) more; less
B) more; more
C) less; less
D) less; more
6) 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.
A) expansionary; raise
B) contractionary; raise
C) expansionary; lower
D) contractionary; lower
7) 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.
A) fall; strengthening
B) fall; weakening
C) rise; strengthening
D) rise; weakening
8) 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.
A) expansionary; raise
B) contractionary; raise
C) expansionary; lower
D) contractionary; lower
9) 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.
A) fall; strengthening
B) fall; weakening
C) rise; strengthening
D) rise; weakening
10) 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.
A) lose; decreasing
B) lose; increasing
C) acquire; decreasing
D) acquire; increasing
11) 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.
A) lose; decreasing
B) lose; increasing
C) acquire; decreasing
D) acquire; increasing
12) 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.
A) purchase; higher; increases
B) purchase; lower; decreases
C) sale; lower; decreases
D) sale; higher; increases
13) 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.
A) purchase; higher; increases
B) purchase; lower; decreases
C) sale; lower; decreases
D) sale; higher; increases
14) To keep from running out of international reserves under the Bretton Woods system, a
country had to implement ________ monetary policy to ________ its currency.
A) expansionary; strengthen
B) expansionary; weaken
C) contractionary; strengthen
D) contractionary; weaken
15) 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.
A) deficit; expansionary
B) deficit; contractionary
C) surplus; expansionary
D) surplus; contractionary
16) 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.
A) deficits; losing
B) deficits; gaining
C) surpluses; losing
D) surpluses; gaining
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18.7 To Peg or Not To Peg: Exchange-Rate Targeting as an Alternative Monetary Policy
Strategy
1) 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.
A) exchange-rate
B) currency
C) monetary
D) inflation
2) Under an exchange-rate targeting rule for monetary policy, a crawling peg
A) fixes the value of the domestic currency to a commodity such as gold.
B) fixes the value of the domestic currency to that of a large, low-inflation country.
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.
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.
3) 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.
A) domestically; anchor
B) domestically; domestic
C) internationally; anchor
D) internationally; domestic
4) Exchange-rate targeting allows a central bank to ________, thus this will ________ the
probability of policy developing a time-inconsistency problem.
A) be governed by a policy rule; decrease
B) follow discretionary policy; decrease
C) be governed by a policy rule; increase
D) follow discretionary policy; increase
5) Which of the following is NOT an advantage to exchange-rate targeting?
A) It provides a strong nominal anchor to keep inflation under control.
B) It provides an automatic rule for policy to help avoid the time-inconsistency problem.
C) It is simple and clear so that the public can easily understand it.
D) It increases the accountability of policymakers.
6) 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.
A) does; directly
B) does not; directly
C) does; not directly
D) does not; not directly
7) 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
A) U.S. dollar.
B) German mark.
C) Swiss franc.
D) Euro.
8) Which of the following is NOT a disadvantage of exchange-rate targeting?
A) It relies on a stable money-inflation relationship.
B) The targeting country gives up an independent monetary policy.
C) The targeting country is left open for a speculative attack.
D) It can weaken the accountability of policymakers.
9) 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.
A) cannot; encourage
B) cannot; discourage
C) can; encourage
D) can; discourage
10) 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
A) Thailand.
B) Mexico.
C) The Philippines.
D) Indonesia.
11) Because many emerging market countries have not developed the political or monetary
institutions that allow the successful use of discretionary monetary policy
A) they have little to gain from pegging their exchange rate to an anchor country like the U.S. or
Germany.
B) they have little to gain from using a nominal anchor, because it would mean a monetary
policy that is overly expansionary.
C) they have very little to gain from an independent monetary policy, but a lot to lose.
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.
12) 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
A) created a currency board.
B) undergone dollarization.
C) adopted a managed exchange system.
D) adopted an exchange rate monetary system.
13) When a country forgoes its own currency and starts using another country’s currency as its
own, we say that this country has
A) created a currency board.
B) undergone dollarization.
C) adopted a managed exchange system.
D) adopted an exchange rate monetary system.
14) The revenue a government gains from issuing money is
A) interest.
B) rent.
C) seignorage.
D) the national dividend.
E) the inflation tax.
15) A country that dollarizes
A) maximizes its seignorage.
B) earns the same amount of seignorage as it would with a currency board.
C) earns the same amount of seignorage as it would with exchange-rate targeting.
D) eliminates its seignorage.
E) must pay seignorage to other governments to use their currency.
16) The seignorage for a government is greater for ________ than for ________.
A) dollarization; a currency board
B) dollarization; exchange-rate targeting
C) dollarization; monetary targeting
D) dollarization; inflation targeting
E) exchange-rate targeting; dollarization
17) The monetary policy strategy that provides an automatic rule for the conduct of monetary
policy is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
18) The monetary policy strategy that does NOT allow the policy to focus on domestic
considerations is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
19) The monetary policy strategy that results in the loss of an independent monetary policy is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
20) The monetary policy strategy that directly ties down the price of internationally traded goods
is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
21) Explain an additional disadvantage for a country undergoing dollarization compared to a
currency board or other exchange-rate targeting regimes.
22) 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?