Financial Markets and Institutions, 6e (Mishkin/Eakins)
Chapter 14 The International Financial System
14.1 Multiple Choice
1) A central bank sale of _________ to purchase _________ in the foreign exchange market
results in an equal rise in its international reserves and the monetary base.
A) foreign assets; domestic currency
B) foreign assets; foreign currency
C) domestic currency; foreign assets
D) domestic currency; domestic currency
2) A central bank sale of _________ to purchase _________ in the foreign exchange market
results in an equal decline in its international reserves and the monetary base.
A) foreign assets; domestic currency
B) foreign assets; foreign currency
C) domestic currency; foreign assets
D) domestic currency; domestic currency
3) A central bank _________ of domestic currency and corresponding _________ of foreign
assets in the foreign exchange market leads to an equal _________ in its international
reserves and the monetary base.
A) sale; purchase; decline
B) sale; sale; increase
C) purchase; sale; increase
D) purchase; sale; decline
4) A central bank _________ of domestic currency and corresponding _________ of foreign
assets in the foreign exchange market leads to an equal _________ in its international
reserves and the monetary base.
A) sale; purchase; increase
B) sale; sale; decline
C) purchase; sale; increase
D) purchase; purchase; decline
5) When the central bank allows the purchase or sale of domestic currency to have an effect on
the monetary base, it is called
A) a sterilized foreign exchange intervention.
B) an unsterilized foreign exchange intervention.
C) an exchange rate feedback rule.
D) a money neutral foreign exchange intervention.
6) A foreign exchange intervention with an offsetting open market operation that leaves the
monetary base unchanged is called
A) an unsterilized foreign exchange intervention.
B) a sterilized foreign exchange intervention.
C) an exchange rate feedback rule.
D) a money neutral foreign exchange intervention.
7) An unsterilized intervention in which domestic currency is sold to purchase foreign assets
leads to
A) a gain in international reserves.
B) an increase in the money supply.
C) an appreciation in the domestic currency.
D) all of the above.
E) only A and B of the above.
8) An unsterilized intervention in which domestic currency is sold to purchase foreign assets
leads to
A) a gain in international reserves.
B) a decrease in the money supply.
C) an appreciation in the domestic currency.
D) all of the above.
E) only A and B of the above.
9) A Federal Reserve decision to sell dollars in order to buy foreign assets in the foreign
exchange market has the same effect as an open market _________ of bonds to _________ the
monetary base and the money supply.
A) sale; decrease
B) purchase; decrease
C) sale; increase
D) purchase; increase
10) A Federal Reserve decision to purchase dollars by selling foreign assets in the foreign
exchange market has the same effect as an open market _________ of bonds to _________ the
monetary base and the money supply.
A) sale; decrease
B) purchase; decrease
C) sale; increase
D) purchase; increase
11) An unsterilized intervention in which the domestic currency is sold to purchase foreign
assets results in an expected _________ of the domestic currency that shifts the RF schedule
to the _________
A) depreciation; right.
B) appreciation; right.
C) depreciation; left.
D) appreciation; left.
12) An unsterilized intervention in which the domestic currency is purchased by selling foreign
assets results in an expected _________ of the domestic currency that shifts the RF schedule
to the _________
A) depreciation; right.
B) appreciation; right.
C) depreciation; left.
D) appreciation; left.
13)
An expected appreciation of the domestic currency that shifts the RF schedule to the left is
caused by a(n) _________ intervention in which the domestic currency is _________.
A) sterilized; sold to purchase foreign assets
B) sterilized; purchased by selling foreign assets
C) unsterilized; sold to purchase foreign assets
D) unsterilized; purchased by selling foreign assets
14) 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
A) causes the exchange rate to overshoot in the short run.
B) causes the exchange rate to undershoot in the short run.
C) causes the exchange rate to depreciate in the short run, but has no effect on the
exchange rate in the long run.
D) has no effect on the exchange rate.
15) Because sterilized interventions mean offsetting open market operations,
A) there is no impact on the monetary base.
B) there is no impact on the money supply.
C) there is no effect on the exchange rate.
D) all of the above occur.
E) only A and B of the above occur.
16) The difference between merchandise exports and imports is called the
A) current account balance.
B) capital account balance.
C) balance of payments.
D) trade balance.
17) A current account _________ indicates that the United States is _________ its claims on
foreign wealth.
A) surplus; increasing
B) surplus; decreasing
C) deficit; increasing
D) balance; decreasing
18) A current account _________ indicates that the United States is _________ its claims on
foreign wealth.
A) deficit; decreasing
B) deficit; increasing
C) surplus; decreasing
D) balance; increasing
19) Holding other factors constant, which of the following would decrease the size of the U.S.
current account deficit?
A) A increase in the amount of services purchased from foreigners
B) An increase in the amount of goods purchases from foreigners
C) An increase in the amount of goods sold to foreigners
D) Only A and B of the above
20) Holding other factors constant, which of the following would increase the size of the U.S.
current account deficit?
A) Sales of U.S. farm products in Europe
B) Visits by European tourists to the United States
C) Increasing travel by American college students in Europe
D) Both A and B of the above
21) The current account balance plus the capital account balance equals
A) the amount of unsterilized exchange market intervention.
B) the trade balance.
C) the net change in government international reserves.
D) both A and C of the above.
22) If the current account balance shows a surplus, and capital account receipts exceed capital
account payments, then the net change in government international reserves must be
_________, indicating a(n) _________ in U.S. international reserves.
A) positive; increase
B) negative; increase
C) negative; decrease
D) positive; decrease
23) Which of the following statements is correct?
A) current account balance = capital account balance
B) current account balance = capital account balance + net change in government
international reserves
C) current account balance + capital account balance = net change in government
international reserves
D) current account balance + net change in government international reserves = capital
account balance
24) The Bretton Woods system was one in which central banks
A) agreed to limit domestic money growth to the average of the seven largest industrial
nations.
B) agreed not to intervene in the foreign exchange market to maintain a fixed exchange
rate regime that had existed prior to World War I.
C) agreed to limit domestic money growth to the average of the five largest industrial
nations.
D) bought and sold their own currencies to keep their exchange rates fixed.
25) 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.
A) IMF
B) World Bank
C) Central Settlements Bank
D) Bank of International Settlements
E) European Exchange Rate Mechanism (ERM)
26) The Bretton Woods agreement set up the _________, which currently provides long–term
loans to assist developing countries to build dams, roads, and other physical capital that
contributes to economic development.
A) International Monetary Fund
B) World Bank
C) Central Settlements Bank
D) Bank of International Settlements
E) European Exchange Rate Mechanism (ERM)
27) What kind of exchange rate system did the Bretton Woods agreement establish?
A) floating
B) managed float
C) dirty float
D) fixed
28) In the Bretton Woods system, the anchor currency was the
A) euro.
B) British pound.
C) German mark.
D) U.S. dollar.
29) Which of the following are true statements about the Bretton Woods system?
A) The Bretton Woods system was a fixed exchange rate regime, in which central banks
bought and sold their own currencies to keep their exchange rates fixed.
B) To maintain fixed exchange rates when countries had balance of payments deficits and
were losing international reserves, the IMF would loan deficit countries international
reserves contributed by other members.
C) The German mark was called a reserve currency because it was used to denominate the
securities central banks held as international reserves.
D) All of the above are true.
E) Only A and B of the above are true.
30) Which of the following are true statements about the Bretton Woods system?
A) The Bretton Woods system was a flexible exchange rate regime, in which central banks
allowed their currencies to float within a wide trading band.
B) The U.S. dollar was called a reserve currency because it was used to denominate the
securities central banks held as international reserves.
C) The Bretton Woods agreement broke down in 1945.
D) Only A and B of the above are true.
31) Under a fixed exchange rate regime, when the domestic currency is undervalued, the central
bank must _________ the domestic currency to keep the exchange rate fixed and as a result it
_________ international reserves.
A) purchase; gains
B) sell; gains
C) purchase; loses
D) sell; loses
32) Under a fixed exchange rate regime, when the domestic currency is overvalued, the central
bank must _________ the domestic currency to keep the exchange rate fixed and as a result it
_________ international reserves.
A) purchase; loses
B) sell; loses
C) purchase; gains
D) sell; gains
33) 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.
A) overvalued; below
B) overvalued; above
C) undervalued; below
D) undervalued; above
34) Under a fixed exchange rate regime, if the domestic currency is initially _________, that is
_________ par, the central bank must intervene to buy the domestic currency by selling
foreign assets.
A) overvalued; below
B) overvalued; above
C) undervalued; below
D) undervalued; above
35) If the domestic currency is initially undervalued, that is below par, the central bank must
intervene to sell the _________ currency by purchasing _________ assets.
A) domestic; foreign
B) domestic; domestic
C) foreign; foreign
D) foreign; domestic
36) 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
37) 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
38) If a country’s central bank eventually runs out of international reserves, it cannot keep its
currency from _________ and a _________ must occur in which the par exchange value is
reset at a _________ level.
A) appreciating; revaluation; higher
B) depreciating; revaluation; higher
C) depreciating; devaluation; lower
D) appreciating; devaluation; lower
39) Depreciation of a currency occurs when
A) a floating exchange rate adjusts upward.
B) a floating exchange rate adjusts downward.
C) a fixed exchange rate is adjusted upward.
D) a fixed exchange rate is adjusted downward.
40) Policy makers may not want to see their country’s currency appreciate because
A) this would hurt consumers in their country by making foreign goods more expensive.
B) this would hurt domestic businesses by making foreign goods cheaper in their country.
C) this would increase inflation in their country.
D) this would decrease the wealth of the country.
41) Under a managed float exchange rate regime, policymakers frequently do not want to see
their currencies depreciate because it makes _________ goods more expensive for _________
consumers and contributes to inflation.
A) foreign; foreign
B) foreign; domestic
C) domestic; foreign
D) domestic; domestic
42) Revaluation of a currency’s value occurs when
A) a floating exchange rate adjusts upward.
B) a floating exchange rate adjusts downward.
C) a fixed exchange rate is adjusted upward.
D) a fixed exchange rate is adjusted downward.
43) Leading up to the foreign exchange crisis of September 1992, the Bank of England wanted to
pursue a(n) _________ monetary policy and the German Bundesbank wanted to pursue a(n)
_________ monetary policy.
A) expansionary, expansionary
B) expansionary; contractionary
C) contractionary; expansionary
D) contractionary; contractionary
44) When the Bundesbank lowered German mark interest rates in September 1992,
A) there was a massive sell–off of German marks, requiring intervention to support the
value of the mark.
B) there was a massive sell–off of British pounds, requiring intervention to support the
value of the pound.
C) there was a gradual sell–off of German marks, which avoided the need for intervention
to support the value of the mark.
D) there was a gradual sell–off of British pounds, which avoided the need for intervention
to support the value of the pound.
45) 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) the end of the Exchange Rate Mechanism.
46) Under the Bretton Woods system, when a nonreserve–currency country was running a
balance of payments deficit,
A) it gained international reserves.
B) it lost international reserves.
C) it was necessary for the policymakers to implement a contractionary monetary policy.
D) both A and C of the above.
E) both B and C of the above.
47) Under a fixed exchange rate system,
A) an anchor country loses control over its monetary policy.
B) a country that ties its currency to that of another country gains control of the other
country’s monetary policy.
C) a country that ties its currency to that of another country loses control over its
monetary policy.
D) a country that ties its currency to that of another country acquires greater control over
its monetary policy.
48) The euro is unlikely to seriously challenge the dollar as a reserve currency as long as
A) the European Union’s share of world GDP remains significantly smaller than that of
the United States.
B) the European Union’s share of world exports remains significantly smaller than that of
the United States.
C) Europe neglects to integrate its financial markets.
D) the European Union is unable to function as a cohesive political entity.
49) Under dollarization a country
A) backs its currency 100 percent with foreign reserves.
B) earns seignorage because it no longer bears the cost of issuing its own currency.
C) abandons its own currency and adopts the money of another country.
D) must worry about a speculative attack on its currency.
50) A disadvantage of dollarization is that it
A) prevents a central bank from creating inflation.
B) avoids the possibility of a speculative attack on the domestic currency.
C) does not allow a country to pursue its own independent monetary policy.
D) is a strong commitment to exchange rate stability.
51) (I) Controls on capital outflows may increase capital flight by weakening confidence in the
government. (II) Controls on capital outflows are an inadequate substitute for financial
reform to deal with currency crises.
A) (I) is true; (II) false.
B) (I) is false; (II) true.
C) Both are true.
D) Both are false.
52) The most effective way to deal with currency crises is to
A) impose controls on capital inflows.
B) impose controls on capital outflows.
C) impose controls on both capital inflows and outflows.
D) improve bank regulation and supervision.
53) An argument that supports the view that the world needs an international lender of last
resort such as the IMF is that
A) central banks in emerging–market countries lack credibility as inflation fighters.
B) an international lender of last resort creates a safety net that protects bank depositors.
C) the IMF is slow to lend, which ultimately reduces the amount that must be borrowed.
D) the IMF imposes requirements that borrowing countries must enact microeconomic
policies to reform their financial systems.
54) In the balance of payments bookkeeping system, payments from foreigners to Americans are
entered in the
A) “Receipts” column with a plus (+) sign to reflect that they are credits.
B) “Receipts” column with a minus (–) sign to reflect that they are debits.
C) “Payments” column with a minus (–) sign to reflect that they are debits.
D) “Payments” column with a plus (+) sign to reflect that they are credits.
55) In the balance of payments bookkeeping system, all payments to foreigners are entered in
the
A) “Receipts” column with a plus (+) sign to reflect that they are credits.
B) “Receipts” column with a minus (–) sign to reflect that they are debits.
C) “Payments” column with a minus (–) sign to reflect that they are debits.
D) “Payments” column with a plus (+) sign to reflect that they are credits.
56) Which of the following appear as credits in the U.S. balance of payments?
A) Capital outflows
B) Foreign aid
C) Merchandise exports
D) All of the above
57) Which of the following appear as debits in the U.S. balance of payments?
A) Capital inflows
B) Merchandise and service exports
C) Foreign aid
D) All of the above
58) In the balance of payments accounting system, the sale of Dell computers abroad are entered
in the _________ column with a _________ sign.
A) receipts; negative
B) receipts; positive
C) payments; negative
D) payments; positive
59) In the balance of payments accounting system, American purchases of BMW automobiles
from Germany are entered in the _________ column with a _________ sign.
A) receipts; negative
B) receipts; positive
C) payments; negative
D) payments; positive
60) In the balance of payments accounting system, American gifts to foreigners are entered in
the _________ column with a _________ sign.
A) receipts; negative
B) receipts; positive
C) payments; negative
D) payments; positive
61) In the balance of payments accounting system, foreign aid is entered in the _________
column with a _________ sign.
A) receipts; negative
B) receipts; positive
C) payments; negative
D) payments; positive
62) In the balance of payments accounting system, capital inflows are entered in the _________
column with a _________ sign.
A) receipts; negative
B) receipts; positive
C) payments; negative
D) payments; positive
63) In the balance of payments accounting system, capital outflows are entered in the _________
column with a _________ sign.
A) receipts; negative
B) receipts; positive
C) payments; negative
D) payments; positive
64) An examination of the U.S. balance of payments indicates that the current account balance
can
A) show a surplus only if the trade balance shows a surplus.
B) show a deficit only if the trade balance shows a deficit.
C) show a deficit even if the trade balance shows a surplus.
D) only A and B of the above.
65) Financial analysts closely follow the current account balance because they believe it can
provide information on the future movement of
A) interest rates.
B) gold flows.
C) exchange rates.
D) special drawing rights.
66) The capital account describes the flow of capital between the United States and other
countries. Capital inflows are
A) American purchases of foreign assets.
B) foreign purchases of American assets.
C) both A and B of the above.
D) neither (a) nor (b) of the above.
67) Which of the following appears in the capital account part of the balance of payments?
A) A gift to an American from his English aunt
B) A purchase by the Honda corporation of a U.S. Treasury bill
C) A purchase by the Bank of England of a U.S. Treasury bill
D) Income earned by the Honda corporation on its automobile plant in Ohio
68) Given the size of the statistical discrepancy needed to balance the balance of payments
account, one can infer that
A) hidden capital flows into the U.S. are inconsequential.
B) items in the balance of payments are measured quite accurately.
C) many international transactions go unrecorded.
D) all of the above.
69) Many believe that the statistical discrepancy is primarily the result of
A) large hidden capital flows into the United States.
B) large hidden capital flows out of the United States.
C) measurement errors due to exchange rate calculations.
D) none of the above.
70) A balance of payments _________ is associated with a _________ of international reserves.
A) deficit; loss
B) deficit; gain
C) surplus; loss
D) balance; gain
71) A balance of payments _________ is associated with a _________ of international reserves.
A) surplus; loss
B) surplus; gain
C) deficit; gain
D) balance; loss
72) The official reserve transactions balance
A) equals the current account balance plus the items in the capital account.
B) tells us the net amount of international reserves that must move between central banks
in order to finance international transactions.
C) has an important impact on the money supply.
D) all of the above.
73) Because other countries hold dollars as international reserves, a U.S. official reserve
transactions deficit can be financed by
A) an increase in U.S. international reserves.
B) an increase in foreign holdings of dollars.
C) a decrease in foreign holdings of dollars.
D) only A and B of the above.
74) When a reserve currency country runs a balance of payments deficit and a nonreserve
currency country buys the reserve currency to finance the reserve country’s deficits, the
monetary base in the nonreserve country _________ and the monetary base in the reserve
country _________
A) increases; decreases.
B) increases; does not change.
C) decreases; does not change.
D) decreases; increases.
75) _________ is when the domestic currency is backed 100% by a foreign currency and in which
the note–issuing authority establishes a fixed exchange rate to this foreign currency and
stands ready to exchange domestic currency for the foreign currency at this rate whenever
the public requests it.
A) Dollarization
B) Currency board
C) Devaluation
D) Revaluation
76) What shows international transactions that involve currently produced goods and services?
A) Current account
B) Balance of payments
C) Trade balance
D) Capital Account
77) What is the bookkeeping system for recording all receipts and payments that have a direct
bearing on the movement for funds between a nation and foreign countries?
A) Current Account
B) Capital Account
C) Balance of payments
D) Trade balance
78) The official reserve transactions balance is referred to as
A) the capital account.
B) the current account.
C) the trade balance.
D) net change in government international reserves.
79) A dirty float is
A) when the value of a currency is pegged relative to the value of one other currency.
B) when the value of a currency is allowed to fluctuate against all other currencies.
C) when countries intervene in foreign exchange markets in an attempt to influence their
exchange rates by buying and selling foreign assets.
D) when the value of a currency is pegged relative to an anchor currency.
80) Seigniorage is
A) when a country abandons its currency altogether and adopts that of another country.
B) when a country loses the revenue that it received by issuing money.
C) when the par exchange rate is reset at a lower level.
D) when the domestic currency is backed 100% by a foreign currency.
14.2 True/False
1) An unsterilized intervention in which domestic currency is sold to purchase foreign assets
leads to a gain in international reserves.
2) The difference between merchandise exports and imports is called the current account
balance.
3) The current account balance plus the capital account balance equals the net change in
government international reserves.
4) A central bank’s international reserves are its holdings of assets denominated in foreign
currencies.
5) In contrast to other countries’ currencies, the Japanese yen and yen–denominated assets are
the major component of international reserves held by countries.
6) An anchor currency provides the base for a floating exchange rate system.
7) In a fixed exchange rate system, a country whose currency is undervalued will lose
international reserves.
8) The Bretton Woods system was a fixed exchange rate regime, in which central banks bought
and sold their own currencies to keep their exchange rates fixed.
9) If a country’s central bank eventually runs out of international reserves, it cannot keep its
currency from depreciating and a devaluation must occur.
10) When it acts as a lender of last resort, the IMF may increase the likelihood that financial
institutions take excessive risks and thus increase moral hazard.
11) An unsterilized intervention in which domestic currency is purchased by selling foreign
assets leads to a rise in international reserves, a decrease in the money supply, and a
appreciation of the domestic currency.
12) A sterilized intervention leaves the money supply changed and has a direct way of affecting
interest rates or the expected future exchange rate.
13) A managed float regime is when countries intervene in foreign exchange markets in an
attempt to influence their exchange rates by buying and selling foreign assets.
14.3 Essay
1) How does a sterilized foreign exchange intervention differ from an unsterilized one in terms
of its effects on the exchange rate, international reserves, and the monetary base?
2) How does a fixed exchange rate regime differ from a system of floating exchange rates?
3) Briefly explain what it means to be a “reserve–currency” country. What are the advantages?
Can you think of any disadvantages?
4) What was the European Monetary System? How did its exchange rate mechanism work?
5) Explain graphically how a country must intervene in the foreign exchange market under a
fixed exchange rate regime if its currency is undervalued.
6) Explain graphically the speculative attacks that occurred against the British pound in 1992,
the Mexican peso in 1994, the Thai baht in 1997, the Brazilian real in 1999, and the Argentine
peso in 2002.
7) What are the arguments for and against the IMF acting as an international lender of last
resort?
8) Describe the pros and cons for controls on capital inflows and outflows.