Chapter 19 – Exchange-Rate Policy and the Central Bank
101. Could a country be open to international capital flows, control its domestic interest rate
and fix its exchange rate? Explain.
102. What are the cost and benefits to a country instituting capital controls?
103. Everything else equal, if the Fed decided to fix the euro/dollar exchange rate, what
would be the impact on the money supply in the U.S. if the euro started to decline in value
and why?
104. Everything else equal, if the Fed decided to fix the euro/dollar exchange rate, what
would be the impact on the interest rate in the U.S. if the euro started to appreciate in value
and why?
105. Using demand and supply analysis, explain why the euro/dollar exchange rate rises (the
dollar appreciates) if the Fed intervenes in the foreign exchange market and sells euros.
Chapter 19 – Exchange-Rate Policy and the Central Bank
106. Are foreign exchange market interventions the only tool available to a central bank to
change the exchange rate? Explain.
107. How would the impact on the exchange rate differ if the Fed were to sell U.S. Treasury
securities instead of selling an equal amount (in $ terms) of euros?
Chapter 19 – Exchange-Rate Policy and the Central Bank
108. What should be the impact on the U.S. interest rates if the Fed undertakes a sterilized
foreign exchange intervention? Be sure to explain your answer.
109. What separates a sterilized foreign exchange market intervention from an unsterilized
intervention?
110. A sterilized intervention is actually a combination of two transactions. What are they and
what is the effect on the monetary base?
Chapter 19 – Exchange-Rate Policy and the Central Bank
111. You are an American resident but have invested in a German bond (paying face value)
that matures in two years, pays a 5 percent interest rate and is denominated in euros. What
could cause your rate of return to fall below 5 percent even though the bond pays off at
maturity?
112. What are the risks to a country of fixing its exchange rate to that of another country?
Chapter 19 – Exchange-Rate Policy and the Central Bank
113. Describe the automatic stabilizers that are lost to a country that fixes its exchange rate to
another currency.
114. What makes countries with fixed exchange rates prone to speculative attacks? Why don’t
the central banks of these countries stop these attacks?
115. How can irresponsible fiscal policy contribute to a speculative attack on a country’s
currency that is fixed in value to another currency?
116. What are the general conditions under which a fixed exchange rate makes sense for a
country?
Chapter 19 – Exchange-Rate Policy and the Central Bank
117. How did the gold standard contribute to the spreading of the Great Depression of the
1930s?
118. What were the reasons for selecting the U.S. dollar as the currency to which the other 43
countries agreed to peg their currencies as part of the Bretton Woods System?
Chapter 19 – Exchange-Rate Policy and the Central Bank
119. What are the pros and cons of a currency board?
120. What are the main costs to a country that adopts dollarization?
Chapter 19 – Exchange-Rate Policy and the Central Bank
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121. Is the European Monetary Union a form of dollarization? Explain.
122. What is the relationship between a nation’s monetary and fiscal policy and its exchange
rate?
Essay Questions
Chapter 19 – Exchange-Rate Policy and the Central Bank
123. If a country has a flexible exchange rate, will high rates of inflation, though generally
harmful, price this country’s goods off world markets? Explain.
124. You live in a small country that suffers constantly from high and variable rates of
inflation. You are quite sure it has something to do with the fact that the head of the central
bank is the President’s brother. A rival presidential candidate is advocating fixing the
exchange rate between your country’s currency and the dollar. What are the advantages to this
proposal and how do you think the current head of the central bank will respond?
Chapter 19 – Exchange-Rate Policy and the Central Bank
125. Completely flexible exchange rates are fairly self-explanatory, and hard pegs include
dollarization and currency boards. These seem to be the extremes. Why do you think soft pegs
are never used?
126. What were the contributing factors that led to Argentina’s initial adoption of a currency
board and then its subsequent failure?
Chapter 19 – Exchange-Rate Policy and the Central Bank
127. Compare the monetary policy of the 50 states that make up the United States to the
exchange rate regime of dollarization.