Chapter 16: Fixed Exchange Rates
MULTIPLE CHOICE
1. Which of the following is the most flexible exchange rate regime?
a. Crawling peg.
b. Crawling band.
c. Managed float.
d. Currency board.
2. Which of the following will not help sustain an overvalued currency?
a. Inflow of foreign aid.
b. Positive net factor receipts.
c. Negative net official reserve transactions.
d. None of the above.
3. Which of the following flows would help to sustain an undervalued currency?
a. Positive net factor receipts.
b. Positive net official reserve transactions.
c. Negative net transfers.
d. Purchases of local currency by the central bank.
4. The equilibrium exchange rate in a fixed exchange rate regime is:
a. The point at which supply of (the trade balance) and demand for (foreign savings) the
home currency intersects.
b. The point at which the demand for the home currency exceeds supply.
c. The point at which the supply of the local currency exceed demand.
d. None of the above.
5. If a country wishes to pursue a fully independent monetary policy, it must:
a. Maintain a fixed exchange rate.
b. Impose capital controls.
c. Maintain a flexible exchange rate.
d. B and C above.
6. If a country wishes to maintain exchange rate stability, it must:
a. Maintain a flexible exchange rate.
b. Allow capital mobility.
c. Maintain a fixed exchange rate.
d. B and C above.
7. Which of the following is not an aspect of a currency board arrangement?
a. An inviolable commitment to a fixed exchange rate.
b. Periodic adjustment of bands.
c. Backing up base money with foreign exchange balances.
d. No monetary independence.
8. According to the interest rate parity condition, if a country wishes to maintain an
equilibrium fixed exchange rate, it must:
a. Must set its interest rate to be higher than the foreign interest rate.
b. Must set its interest rate to be lower than the foreign interest rate.
c. Must set its exchange rate equal to the foreign exchange rate.
d. Must set its interest rate equal to the foreign interest rate.
9. The relationship between fixed exchange rates and foreign reserves is as follows:
a. In an overvaluation, the central bank draws down foreign reserves.
b. In an overvaluation, the central bank builds up foreign reserves.
c. In an undervaluation, the central bank draws down foreign reserves.
d. None of the above.
10. Which of the following is not one of the three desired outcomes included in the
impossible trinity?
a. Monetary independence.
b. Full employment.
c. Exchange rate stability.
d. Capital mobility.
TRUE/FALSE
1. In a fixed exchange rate regime, when a government increases the nominal rate or lowers
the value of the currency, it is called a deprecation.
2. In a fixed exchange rate regime, when a government increases the nominal exchange rate
or lowers the value of the currency, it is called a devaluation.
3. In a flexible exchange rate regime, when market forces cause a fall in the value of a
country’s currency, it is called a devaluation.
4. In a flexible exchange rate regime, when market forces cause a fall in the value of a
country’s currency, it is called a depreciation.
5. In a fixed exchange rate regime, when a government decreases the nominal exchange rate
or increases the value of the currency, it is called an appreciation.
6. In a fixed exchange rate regime, when a government decreases the nominal exchange rate
or increases the value of the currency, it is called a revaluation.
7. In a flexible exchange rate regime, when market forces cause an increase in the value of a
country’s currency, it is called a revaluation.
8. In a flexible exchange rate regime, when market forces cause an increase in the value of a
country’s currency, it is called a appreciation.
9. Central banks in countries with overvalued currencies tend to build up foreign reserves.
10. Central banks in countries with overvalued currencies tend to draw down foreign
reserves.
11. Central banks in countries with undervalued currencies tend to build up foreign reserves.
12. Central banks in countries with undervalued currencies tend to draw down foreign
reserves.
13. A country can maintain capital mobility and monetary independence only if it has a fixed
exchange rate.
14. A country can maintain monetary independence and exchange rate stability only by
maintaining controls of capital flows or limits to capital mobility.
15. A country can maintain capital mobility and exchange rate stability only if it has a fixed
exchange rate.
SHORT ANSWER
1. What is the difference between crawling peg and crawling band exchange rate regimes?
2. Which exchange rate arrangement requires that the domestic currency be fully backed up
by reserves of the foreign currency to which it is pegged?
3. Why might a country engage in managed or “dirty” floating?
4. How can a country with a fixed exchange rate regime sustain an overvalued currency?
5. How can a country with a fixed exchange rate regime sustain an undervalued currency?
6. Suppose that two countries have identical interest rates, with country A pegging its
currency to country B. What must country A do to maintain exchange rate equilibrium if
the interest rate in country B rises?
7. Suppose that two countries have identical interest rates, with country A pegging its
currency to country B. What must country A do to maintain exchange rate equilibrium if
the interest rate in country B falls?
8. What is the importance of the impossible trinity idea?
9. What shortcomings of currency boards were demonstrated by the 2001-2002 crisis in
Argentina?