PART FOUR: OPEN ECONOMY MACROECONOMICS
CHAPTER 14: EXCHANGE RATES AND THE
INTERNATIONAL MONETARY SYSTEM
Additional Questions
Questions and/or Problems:
1. What is the main cost of maintaining a fixed exchange rate? Provide two reasons, then, why
countries fix their exchange rates.
2. What is a major advantage of flexible exchange rates?
3. What was the goal of the Bretton Woods agreement? Why did it collapse?
4. Can a central bank control domestic interest rates and fix their exchange rate at the same
time? Explain, focusing on the implications for the use of stabilization policy.
5. What impact does an increase in the money supply have on a countries exchange rate in a
floating exchange rate system? Provide a graph of the foreign exchange market to illustrate.
6. Assuming that the euro-U.S. dollar exchange rate is .9. If a German buys an American
automobile for $30,000, then what would the automobile cost in Euros? What would the
automobile cost if the dollar depreciated by 20 percent?
7. Explain what has happened to the value of the dollar since 1988, paying particular attention
to what has happened since 2001.
8. What is meant by “statistical discrepancy? How does it relate to the current account, capital
account, and official reserve transactions?
9. If fiscal policy was used to keep interest rates fixed in the face of changes in monetary
policy, would an increase in the money supply still affect the exchange rate in a flexible
Additional Essay Questions and/or Problems:
10. Illustrate graphically the way in which the exchange rate is determined in a flexible
exchange rate system. Now assume that an expansionary monetary policy action is taken.
Illustrate the effects that this policy action will have on the foreign exchange market.
11. The U.S. dollar has depreciated sharply against the euro since 2001. What explanations can
you offer for this depreciation of the dollar? Provide graphs to illustrate.
12. Briefly detail how the Bretton Woods system worked. If a country was running a current
account deficit, how would it pay for it? Do you see any potential limits to permanently
running current account deficits?
13. Discuss the breakdown of the Bretton Woods system. Why did it occur? Why did it occur
when it occurred?
14. Briefly describe today’s international exchange rate system, including an explanation of
how foreign exchange markets.
15. True/False/Explain, using what you know about the balance of payments. “The U.S. not
only runs a large trade surplus with China, but lends China quite a bit of money which
could be used for purchasing new investment and capital in the U.S.”
16. Discuss the role that the euro currency union has played in the European sovereign debt
crisis that began in 2009. If the euro was abandoned, how would a floating exchange rate
system impact the sovereign debt crisis? Explain.
17. What is dollarization? Does dollarization increase or decrease the stability of
macroeconomies? Explain.
18. Ben Bernanke, chairman of the US Federal Reserve, has talked about the problems
associated with the “global savings glut”. What is this global savings glut? Explain its cause
using the US and China Balance of Payments and equation 14.4.
Multiple-Choice Questions:
1. The current account in a nation’s balance of payments accounts includes
2. In a system of flexible exchange rates, expansionary monetary policy abroad would induce
3. With a fixed exchange rate, an increase in the domestic price level will, for a constant
foreign price level,
4. Which of the following statements is (are) correct?
5. One explanation for the fall in the value of the U.S. dollar since 2001is
6. In a system of perfectly flexible exchange rates, an expansionary U.S. monetary policy will
cause
7. Under a fixed exchange rate system, the exchange rate
8. The U.S. dollar exchange rate describes the
9. Assume that the fixed exchange rate system of 100 pesos = 1 dollar is above the
equilibrium exchange rate of 90 pesos= 1 dollar in a flexible exchange rate system. Then
10. Capital inflows in the balance of payments accounts include
11. A current account deficit in a nation’s balance of payments accounts implies that
12. A supply of foreign exchange occurs in the United States when
13. A decline in the exchange rate means that
14. Assuming that the exchange rate rises by 5 percent, hence, the dollar volume of exports
rises by 5 percent, then foreign exchange earnings would
15. A system of exchange rate determination with no central bank intervention is a
16. Assume that the fixed exchange rate system of 1.1 euros = 1 dollar is below the equilibrium
exchange rate of 1.3 euros = 1 dollar in a flexible exchange rate system. Then, at the fixed
exchange rate, the dollar would be
17. The higher the exchange rate, the
18. The Bretton Woods system
19. An advantage of a flexible exchange rate system relative to a fixed system is that in a
flexible rate system
20. The current international monetary system is best described as a
21. In a system of flexible exchange rates, lower inflation abroad would induce
22. Alternative proposals to change the current system of exchange rates include a. a new
explicit system of fixed exchange rates.
23. The United States balance of payments accounts
24. The official reserve transactions balance in the United States balance of payments accounts
is
25. Capital outflows in the balance of payments accounts include
26. Total credits in the balance of payments accounts are equal to the
27. Under a fixed exchange rate system, the central bank must
28. A trade deficit can be financed by all of the following except
29. Assuming a flexible exchange rate, then an expansionary monetary policy in the foreign
exchange market will shift
30. The statistical discrepancy is
31. Which of the following statements is (are) correct? During the existence of the Euro
(1999-),
32. Which of the following statements is (are) correct? Under a floating exchange rate system
33. A trade surplus could be balanced by all of the following except
34. Goods produced in the U.S. are made more competitively priced when
35. Which of the following are advantages of greater exchange rate flexibility?
36. Assuming the United States sends foreign aid payments to another country. Then, this is
shown in the U.S. balance of payments account as a
37. The exchange rate between the dollar and the euro is
38. Capital outflows in the balance of payments accounts include
39. If the surplus in the capital account are greater than the deficit in the current account, then
40. In the U.S. balance of payments, exports to Europe are recorded as a
41. In a floating exchange rate system, when national savings falls then the equilibrium
exchange rate
42. In a floating exchange rate system, an appreciation of the exchange rate could be caused by
43. In a floating exchange rate system, an increase in the value of the exchange rate could be
caused by
44. Under the Bretton Woods system,
45. An decrease in domestic savings
46. In a system of flexible exchange rates, a reduction in the money supply will cause
47. An increase in U.S. official reserve assets is entered in the U.S. balance of payments
accounts as a
48. To maintain a fixed exchange rate, when the exchange rate moves above the target level,
49. Within a system of perfectly flexible exchange rates, an decrease in the United States
demand for imports would result in a
50. Under a fixed exchange rate system, the central bank must
51. If total domestic savings exceeds domestic investment, then the country will:
52. If a country imposes a tariff on all imports, then you would expect to see:
53. Which of the following should depreciate a county’s currency?
54. To maintain a fixed exchange rate, in response to an increase in the government budget
deficit the central bank must
55. Debits (negatives) in the current account of the balance of payments accounts include