International Economics, 9e (Husted/Melvin)
Chapter 16 Theories of the Current Account Balance
16.1 Multiple-Choice Questions
1) If U.S. export contracts are written in terms of foreign currency and import contracts are
denominated in domestic currency, a devaluation of the dollar during the currency contract
period
A) should increase the dollar value of exports.
B) should not have any effect on the dollar value of U.S. imports.
C) must increase the BOT.
D) All of the above
2) The notion that, following a devaluation, the BOT falls for a while before increasing is called
a ________ effect.
A) relative price
B) elasticity
C) J-curve
D) pass-through
3) Suppose that the United Kingdom devalues the pound. If both exports and imports are written
in terms of pounds, then the United Kingdom balance of trade ________ during a currency
contract period.
A) improves
B) worsens
C) is unaffected
D) falls for a while before increasing
4) The ________ analysis considers the ability of domestic and foreign prices to adjust to
devaluation in the short run.
A) pass-through
B) absorption
C) adjustment mechanism
D) currency contract period
5) The shorter the “pass-through” period, the ________ the desirable BOT effects of devaluation
on quantities traded will appear.
A) sooner
B) longer
C) bigger
D) smaller
6) The balance of trade can only worsen if income ________ relative to absorption.
A) increases
B) decreases
C) does not change
D) None of the above
7) Empirical evidence regarding the effects of devaluation on the balance of trade indicates that
A) devaluation generally improves the BOT.
B) devaluation generally hurts the BOT.
C) no strong generalizations are possible.
D) devaluation has no effect on the BOT.
8) If devaluation does not improve the BOT, but only the BOP, this implies that
A) the capital account is in deficit.
B) the current account is in surplus.
C) the improvement comes in the capital account.
D) Both B and C.
9) Which of the following are theories of the BOT?
A) monetary approach
B) absorption approach
C) elasticities approach
D) Both B and C
10) Which of the following is not appropriate, if we live in a world of fixed exchange rates?
A) monetary approach to the exchange rate
B) elasticities approach
C) monetary approach to the BOP
D) absorption approach
11) With fixed exchange rates, the adjustment to changes in international monetary conditions
comes through
A) exchange rate changes.
B) exchange rate changes and international money flows.
C) international money flows.
D) None of the above.
12) Which of the following is not correct for a small open economy?
A) She cannot improve her BOT.
B) She cannot affect the international price of goods.
C) She cannot affect the foreign interest rate.
D) All of the above.
13) With fixed exchange rates, an increase in the foreign inflation rate, with constant income and
domestic credit, will lead to
A) a change in the exchange rate.
B) an increase in international reserves.
C) a decrease in international reserves.
D) no change in international reserves.
14) The ________ analyzes the BOP and exchange rates in terms of money supply and money
demand.
A) elasticities approach
B) “pass-through of devaluation”
C) monetary approach
D) absorption approach
15) With a managed float, monetary disequilibrium is eliminated through
A) international reserve flows.
B) exchange rate changes.
C) international reserve flows and exchange rate changes.
D) None of the above.
16) In the case of purely flexible exchange rates, a decrease in domestic real income, with
constant prices and domestic credit, will lead to
A) an increase in international reserves.
B) the depreciation of the domestic currency.
C) the appreciation of the domestic currency.
D) no change in the value of the domestic currency.
17) Under a managed float system, central banks can
A) allow international reserve changes.
B) let exchange rates adjust to market pressure.
C) experience reserve changes and exchange rate changes.
D) All of the above.
18) The ________ is a theory of the balance of trade that emphasizes how domestic spending on
domestic goods changes relative to domestic output.
A) absorption approach
B) monetary approach
C) pass-through analysis
D) elasticities approach
19) According to the MABP, BOP disequilibria
A) must be transitory.
B) are essentially real phenomena.
C) must be permanent.
D) are not important.
20) Both the ________ do not put a great deal of emphasis on the capital account.
A) absorption and monetary approaches
B) monetary and elasticities approaches
C) elasticities and absorption approaches
D) None of the above
21) Which of the following has been offered as a possible explanation to the evidence that the
exchange-rate pass-through effect to import prices has been declining in developed economies?
A) That foreign exporters have been increasingly adopting “pricing-to-market” policies.
B) That transaction costs have decreased in recent years.
C) That global leaders have encouraged this phenomenon.
D) That the share of imports with prices more sensitive to exchange rates has been increasing.
22) Suppose that the Japanese yen appreciates significantly at some point, thus making Japanese
imports more expensive. Japanese exporters may lower their profit margins to reduce the effect
of the yen appreciation on U.S. importers, producing a phenomenon known as
A) the J-curve.
B) the absorption effect.
C) pricing to market.
D) international reserves compliance.
23) The fact that the balance of trade normally falls before increasing after a devaluation is
known as
A) the J-curve.
B) the pass-through effect.
C) the balance of payments paradox.
D) the indifference reflection.
24) If the price of a good rises by 10% and the quantity purchased falls by 5%, then demand for
the good is ________ and total spending on the good will ________.
A) elastic; increase
B) inelastic; increase
C) elastic; decrease
D) me and so inelastic; decrease
25) If the price of a good rises by 10% and the quantity purchased falls by 15%, then demand for
the good is ________ and total spending on the good will ________.
A) elastic; increase
B) inelastic; increase
C) elastic; decrease
D) me and so inelastic; decrease
26) If a country’s currency depreciates, then its exports will cost ________ abroad and its
imports will cost ________ domestically.
A) less; less
B) less; more
C) more; less
D) more; more
27) If a country’s currency appreciates, then its exports will cost ________ abroad and its
imports will cost ________ domestically.
A) less; less
B) less; more
C) more; less
D) more; more
16.2 True or False Questions
1) J-curve effects following a devaluation are simply a theoretical issue with no real world
importance.
2) The longer the “pass-through” period following a devaluation, the faster the desirable balance
of trade effects of a devaluation will appear on quantities traded.
3) The evidence available suggests that the effects of devaluation appear to differ across
countries and time so that no strong generalizations regarding the effects of devaluation on the
balance of trade and/or balance of payments are possible.
4) If devaluation improves only the BOP, rather than the BOT, this implies that the capital
account must have improved following a devaluation.
5) The absorption approach is a theory of the balance of payments that emphasizes how domestic
spending on domestic goods changes relative to domestic output.
6) The elasticities approach and the absorption approach are theories of the balance of trade that
emphasize trade in real goods and have little to say about the capital account.
7) The international adjustment mechanism for flexible exchange rates is the same as for
managed float regimes.
8) An increase in real income with constant prices and domestic credit leads to the same effects
under both fixed and purely flexible exchange rates.
9) With a flexible exchange rate, a nation can choose an inflation rate independent of the rest of
the world.
10) The net effect of a devaluation on economic growth depends on the mix of capital and labor
utilized in the nation’s export industries.
11) There is evidence that the exchange-rate pass-through effect to import prices has been
declining in developed economies, especially for the United States.
12) “Pricing-to-market” is a business practice that was common in the twentieth century, but has
now all but disappeared.
13) The reported reduction in the exchange-rate pass through to import prices means that U.S.
inflation will be relatively insensitive to exchange rate changes.
16.3 Essay Questions
1) What is the difference between the monetary approach to the exchange rate and monetary
approach to the balance of payments? Briefly summarize the policy implications of the
monetary approach.
2) Discuss the short-run and long-run views of PPP. Make sure that you explain the underlying
adjustment mechanism and theoretical reasoning for each view when answering the question.
Which view, do you think, is more likely to represent the real world?
3) Write down a model that will allow you to analyze the BOP and exchange rate in a monetary
framework. Then, discuss the consequences of an increase in the foreign inflation rate under
fixed, flexible, and managed floating systems.
4) Is the “international adjustment mechanism” for fixed and flexible exchange rates the same?
Discuss briefly.
5) Explain the elasticities and absorption approaches to the BOT. What is the most notable
shortcoming of these approaches?
6) What is pricing to market? Where is it most prevalent?
7) Recent evidence regarding the exchange-rate pass-through effect in the U.S. reflects a
declining trend. How can this be explained?