10) A decline in the exchange rate could have been caused by which of these factors?
A) A decline in domestic output (income)
B) An increase in the domestic real interest rate
C) A decline in the world demand for domestic goods
D) An increase in foreign output (income)
11) The U.S. real interest rate rises relative to the British real interest rate. British net exports
________ and the British exchange rate ________.
A) increase; rises
B) increase; falls
C) decrease; rises
D) decrease; falls
12) The Japanese real interest rate declines relative to the German real interest rate. German net
exports ________ and the German exchange rate ________.
A) increase; rises
B) increase; falls
C) decrease; rises
D) decrease; falls
13) Identify changes in two variables that would shift the supply curve of dollars to the right.
Identify changes in two variables that would shift the demand curve for dollars to the right.
14) What happens in the short run in the Keynesian model to the exchange rate and net exports in
each of the following cases?
(a) The foreign real interest rate falls.
(b) Foreign output rises.
(c) Foreign demand for domestic goods rises.
(d) Domestic output rises.
(e) The domestic real interest rate falls.
15) Describe the effects of a rise in the domestic real interest rate on the exchange rate and on
both domestic and foreign net exports.
13.3 The IS-LM Model for an Open Economy
1) Goods market equilibrium in the open economy occurs when
A) desired saving equals desired investment.
B) output equals desired consumption plus desired investment plus government spending.
C) desired consumption equals desired investment.
D) desired saving minus desired investment equals net exports.
2) In an open economy, a decrease in net exports because of reduced demand for domestic
products by foreigners should cause the domestic real interest rate to ________ and should cause
desired saving minus desired investment to ________.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
3) A decrease in foreign output would cause the domestic country’s net exports to ________ and
cause the domestic country’s IS curve to ________.
A) rise; shift up
B) rise; shift down
C) fall; shift up
D) fall; shift down
4) An increase in foreign output would cause the domestic country’s net exports to ________ and
cause the domestic country’s IS curve to ________.
A) rise; shift up
B) rise; shift down
C) fall; shift up
D) fall; shift down
5) A decrease in the foreign real interest rate would cause the domestic country’s net exports to
________ and cause the domestic country’s IS curve to ________.
A) rise; shift up
B) rise; shift down
C) fall; shift up
D) fall; shift down
6) A shift in demand toward the home country’s goods would ________ the domestic real
interest rate and ________ net desired saving (desired saving less desired investment) in the
economy.
A) lower; increase
B) lower; decrease
C) raise; increase
D) raise; decrease
7) In an open economy, a shift down and to the left of the IS curve could have been caused by
A) a decline in the foreign real interest rate.
B) an increase in the demand for domestic goods relative to foreign goods.
C) an increase in foreign output.
D) a decline in domestic output.
8) In an open economy, an increase in foreign output would cause the IS curve to shift ________
and a decrease in the foreign real interest rate would cause the IS curve to shift ________.
A) down; down
B) down; up
C) up; down
D) up; up
9) In a Keynesian model, what are the short-run effects on output, the real interest rate, and the
real exchange rate, for both the domestic economy and a foreign economy, of a decline in
investment?
13.4 Macroeconomic Policy in an Open Economy with Flexible Exchange Rates
1) In the Keynesian model of an open economy, a temporary decrease in government purchases
would ________ the domestic real interest rate and ________ net desired saving (desired saving
less desired investment) in the economy.
A) lower; increase
B) lower; decrease
C) raise; increase
D) raise; decrease
2) A temporary increase in government purchases would ________ the domestic real interest rate
and ________ net desired saving (desired saving less desired investment) in the economy.
A) lower; increase
B) lower; decrease
C) raise; increase
D) raise; decrease
3) A temporary decrease in government purchases would ________ the domestic real interest
rate and ________ net desired saving (desired saving less desired investment) in the economy.
A) lower; increase
B) lower; decrease
C) raise; increase
D) raise; decrease
4) In a Keynesian model, a temporary increase in government purchases would cause output to
________ and the domestic real interest rate to ________, in the short run.
A) remain unchanged; increase
B) remain unchanged; decrease
C) increase; increase
D) increase; decrease
5) In the short run in the Keynesian model, an increase in the domestic money supply would
cause domestic output to ________ and the domestic real interest rate to ________.
A) rise; rise
B) fall; rise
C) rise; fall
D) fall; fall
6) An increase in the U.S. money supply would cause the value of the dollar to ________ and
U.S. net exports to ________ in the short run using a Keynesian model.
A) fall; fall
B) fall; rise
C) rise; rise
D) rise; fall
7) The Federal Reserve has just purchased bonds in the market, carrying out open market
operations. In the short run in the Keynesian model, this would cause the foreign real interest rate
to ________ and foreign output to ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
8) According to the classical model, an increase in the American nominal money supply would
cause the nominal exchange rate to ________ and the real exchange rate to ________.
A) depreciate; appreciate
B) appreciate; depreciate
C) depreciate; remain unchanged
D) appreciate; remain unchanged
9) Suppose Japan is currently running a current account surplus. The most effective way of
eliminating this current account surplus would be to temporarily ________ government
purchases and ________ the domestic money supply.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
10) You have just noticed that the dollar appreciated and you suspect that the American
government was behind this change. Which would you choose as the most likely cause of this
appreciation in the real exchange rate?
A) An increase in the money supply
B) A decrease in the money supply
C) A temporary increase in government purchases
D) A temporary decrease in taxes
11) Assume the United States is currently running a current account deficit. The most effective
way of eliminating this current account deficit would be to temporarily ________ government
purchases and ________ the domestic money supply.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
12) To encourage more investment, Mexico has lowered its tax rates to reduce the user cost of
capital. Argentina is unable to pay back its foreign debts, causing its expected future marginal
product of capital to fall. Mexico’s real exchange rate will ________ and its net exports will
________.
A) depreciate; fall
B) appreciate; rise
C) depreciate; rise
D) appreciate; fall
13) Describe the effects of contractionary fiscal policy by the domestic government on output,
the real interest rate, and net exports in both the domestic and foreign country, using a Keynesian
model.
14) Describe the effects of contractionary monetary policy by the domestic central bank on
output, the real interest rate, and net exports in both the domestic and foreign country, using a
Keynesian model in the short run. What happens in the long run? Show a diagram to illustrate
the short-run and long-run effects in both countries.
15) For this question, use the Keynesian IS-LM model with flexible exchange rates.
Eastland’s main trading partner is Westland. Suppose Westland undertakes an expansionary
monetary policy.
(a) What is the effect of Westland’s expansionary monetary policy on Eastland’s real exchange
rate in the short run, assuming no change in Eastland’s policies?
(b) What is the effect of Westland’s expansionary monetary policy on Eastland’s real exchange
rate in the long run, assuming no change in Eastland’s policies?
(c) What is the effect of Westland’s expansionary monetary policy on Eastland’s nominal
exchange rate in the short run and in the long run?
13.5 Fixed Exchange Rates
1) Under a system of fixed exchange rates, what happens if a country’s currency is overvalued?
A) The central bank loses official reserve assets.
B) The central bank gains official reserve assets.
C) The currency appreciates.
D) The exchange rate rises.
2) Under a system of fixed exchange rates, what happens if a country’s currency is undervalued?
A) The central bank loses official reserve assets.
B) The central bank gains official reserve assets.
C) The currency depreciates.
D) The exchange rate falls.
3) If a country has an overvaluation problem, the best solution is to
A) increase the official rate.
B) buy less of its currency in the foreign exchange market.
C) sell more of its currency in the foreign exchange market.
D) decrease the money supply.
4) If the fundamental value of the exchange rate is ________ than the official (fixed) exchange
rate, the country has an ________ problem, and it will gain reserves.
A) less; overvaluation
B) greater; overvaluation
C) less; undervaluation
D) greater; undervaluation
5) If a country that fixes its exchange rate has an undervalued exchange rate, then it will
________ reserves, unless it ________ its money supply to the appropriate level.
A) gain; increases
B) lose; increases
C) lose; decreases
D) gain; decreases
6) International businesses like a fixed-exchange-rate system because
A) they like large swings in currency values when devaluation or revaluation occur.
B) they profit by speculating on devaluation or revaluation.
C) they can plan better if they know what the exchange rate will be.
D) fixed exchange rates are economically efficient.
7) When a group of countries agree to share a common currency, they are said to have formed a
A) currency union.
B) welfare state.
C) monetary alliance.
D) monetary cartel.
8) The currency created by the European Monetary Union, for which notes and coins became
available in 2002, is the
A) ECU.
B) euro.
C) EMU.
D) pound.
9) Currency unions are rare because
A) they’re to no one’s advantage.
B) countries are reluctant to give up having their own currencies.
C) having flexible exchange rates has the same benefits and none of the costs.
D) speculative attacks are likely to occur.
10) Compared to a system of fixed exchange rates, currency unions are beneficial because they
A) allow exchange rates to float.
B) allow every country to have an independent monetary policy.
C) reduce the costs of trading goods and assets.
D) restrict what countries can do with fiscal policy.
11) Compared with a system of fixed exchange rates, currency unions are beneficial because
they
A) restrict what countries can do with fiscal policy.
B) allow exchange rates to float.
C) allow every country to have an independent monetary policy.
D) eliminate the possibility of speculative attacks.
12) Monetary policy in the European Monetary Union is determined by
A) the Bundesbank.
B) the European Union Senate.
C) the European Central Bank.
D) None of the above.
13) The Maastricht treaty was the first step toward
A) having free trade between Russia and China.
B) European monetary union.
C) gaining credibility for monetary policy.
D) reducing the costs of disinflation.
14) A classical economy is described by the equations
AD: Y = 1000 + 100M/P
AS: = 1500
The real exchange rate is 3 bushels/bottle, the domestic nominal money supply is 30 florins, and
the foreign price level is 8 crowns/bushel.
(a) What is the nominal exchange rate?
(b) If the government wants to maintain an official nominal exchange rate of 6 crowns/florin,
what must the nominal money supply be?
15) (a) What happens to the fundamental value of a country’s exchange rate when it raises its
money supply in a fixed-exchange-rate system? Does this make the currency overvalued or
undervalued if originally the official rate equaled the fundamental value?
(b) What happens to the fundamental value of a country’s exchange rate when the foreign
country raises its money supply? Does this make the currency overvalued or undervalued if
originally the official rate equaled the fundamental value?
(c) So, if a country wants to maintain its official rate equal to its fundamental value, what must it
do when the foreign country raises its money supply? What happens to inflation?
16) Describe how the euro was created. What are the benefits of the monetary union? What are
the costs?