12) How might a U.S. federal budget surplus affect the balance of trade? (Assume exchange rates are
stated in terms of foreign currency per U.S. dollar.)
A) A federal budget surplus raises interest rates, which raises exchange rates, and increases the balance
of trade.
B) A federal budget surplus raises interest rates, which raises exchange rates, and reduces the balance of
trade.
C) A federal budget surplus reduces interest rates, which raises exchange rates, and reduces the balance
of trade.
D) A federal budget surplus reduces interest rates, which reduces exchange rates and increases the
balance of trade.
13) How does a decrease in the federal budget deficit affect the demand for dollars and the supply of
dollars on the foreign exchange market?
A) The demand for dollars falls, and the supply of dollars falls.
B) The demand for dollars rises, and the supply of dollars rises.
C) The demand for dollars rises, and the supply of dollars falls.
D) The demand for dollars falls, and the supply of dollars rises.
14) How would an increase in the U.S. federal budget deficit affect the exchange rate in the market for
dollars?
A) The exchange rate will increase.
B) The exchange rate will decrease.
C) The exchange rate will not be affected by a change in the federal budget deficit.
D) The impact of the increase in the federal budget deficit on the exchange rate cannot be predicted.
15) The federal budget deficit and the trade balance are often referred to as the
A) balance of payments.
B) dueling depreciators.
C) twin deficits.
D) national debt.
16) A decrease in U.S. federal government budget deficits that lowers U.S. interest rates relative to the
rest of the world should
A) lower the trade balance.
B) decrease net exports.
C) cause the dollar to appreciate.
D) lead to a current account surplus.
E) increase foreign portfolio investment.
17) The current account deficits incurred by the United States in the 1980s were caused, in the opinion of
many economists, by
A) federal budget deficits.
B) “flight to quality” as foreign investors favored U.S. investments.
C) a sharp decline in private saving.
D) Both B and C are correct.
18) The current account deficits incurred by the United States in the 1990s and early 2000s were caused,
in the opinion of many economists, by
A) federal budget deficits.
B) “flight to quality” as foreign investors favored U.S. investments.
C) a sharp decline in private saving.
D) Both B and C are correct.
19) Persistent current account deficits for the United States have
A) decreased investment in new plant and equipment.
B) slowed economic growth.
C) increased government budget deficits.
D) None of the above are correct.
20) An increase in the government budget deficit will not lead to a current account deficit if domestic
investment declines.
21) The large budget deficits of the early 1990s resulted in large current account deficits.
22) Ceteris paribus, an increase in the government budget deficit increases interest rates in the United
States and causes a real appreciation of the dollar.
23) Ceteris paribus, an increase in the government’s budget deficit will increase the current account
deficit.
24) Ceteris paribus, an increase in the government’s budget deficit will decrease the financial account
surplus.
25) Ceteris paribus, a decrease in the government’s budget deficit will increase domestic investment and
net foreign investment.
26) An increase in perceived risk of foreign assets increased both the financial account surplus and
current account deficit in the United States during the late 1990s.
27) Explain why the budget deficit and the trade deficit are sometimes referred to as the “twin deficits.”
28) What happens to national saving when the government runs a budget surplus? What happens to
national saving when the government runs a budget deficit?
29) Why does continued foreign investment in U.S. stocks and bonds and foreign companies continuing
to build factories in the United States result in a current account deficit in the United States?
30) How does an increase in government purchases financed by an increase in the deficit affect
exchange rates? Support your answer with graphs of the loanable funds market and the foreign
exchange market.
18.5 Monetary Policy and Fiscal Policy in an Open Economy
1) Expansionary monetary policy will have what effect on the components of aggregate demand?
A) Consumption, investment, and net exports will rise.
B) Consumption and investment will rise, but net exports will fall.
C) Consumption will rise, but investment and net exports will fall.
D) Consumption will fall, but investment and net exports will rise.
2) Which of the following is not “crowded out” by higher interest rates as a result of expansionary fiscal
policy?
A) consumption
B) private investment
C) net exports
D) government spending
3) If the Fed does not take into account the additional policy channels available in an open economy,
then ________ when conducting contractionary monetary policy.
A) it is likely to decrease GDP too much and cause a recession
B) it is likely to decrease GDP too little and inflation will persist
C) it is likely to increase GDP too much and inflation will persist
D) it is likely to increase GDP too little and cause a recession
4) If the government finances an increase in government purchases with an increase in taxes, which of
the following would you not expect to see?
A) an increase in the exchange rate
B) a decrease in the interest rate
C) an increase in aggregate demand
D) a decrease in net exports
5) How does expansionary monetary policy affect net exports?
A) Expansionary monetary policy increases exports and reduces imports.
B) Expansionary monetary policy reduces exports and increases imports.
C) Expansionary monetary policy increases exports and increases imports.
D) Expansionary monetary policy reduces exports and reduces imports.
6) Suppose the Fed pursues a policy that leads to higher interest rates in the United States. How will
this policy affect real GDP in the short run if the United States is an open economy? This policy
A) reduces investment spending, consumption spending and net exports, all of which reduce GDP.
B) reduces investment spending and consumption spending, both of which reduce GDP. Net exports
rise which increases GDP.
C) reduces investment spending and consumption spending, both of which reduce GDP. Net exports
fall which increases GDP.
D) increases investment spending, consumption spending, and net exports, all of which increase GDP.
7) Why is the multiplier for contractionary fiscal policy smaller in an open economy?
A) Contractionary fiscal policy reduces the deficit, which raises the interest rate, which raises the
foreign exchange value of the dollar, which increases net exports.
B) Contractionary fiscal policy increases the deficit, which raises the interest rate, which reduces the
foreign exchange value of the dollar, which increases net exports.
C) Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the
foreign exchange value of the dollar, which increases net exports.
D) Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the
foreign exchange value of the dollar, which decreases net exports.
8) If the Fed is using policy to combat inflation, what is likely to happen in the foreign exchange market
and to the foreign exchange value of the dollar?
A) The demand for the dollar will increase and the foreign exchange value of the dollar will rise.
B) The demand for the dollar will decrease and the foreign exchange value of the dollar will rise.
C) The demand for the dollar will increase and the foreign exchange value of the dollar will fall.
D) The demand for the dollar will decrease and the foreign exchange value of the dollar will fall.
9) Which of the following would you expect to increase both interest rates and exchange rates?
A) expansionary monetary policy
B) contractionary monetary policy
C) expansionary fiscal policy
D) Both B and C will increase both interest rates and exchange rates.
10) The impact of crowding out
A) is larger in a closed economy as compared to an open economy.
B) is larger in an open economy as compared to a closed economy.
C) is larger in an open economy as compared to a closed economy when fiscal policy is contractionary.
D) is larger in a closed economy as compared to an open economy when fiscal policy is contractionary.
11) Monetary policy has a ________ effect on aggregate demand in a(n) ________ economy, and fiscal
policy has a ________ effect on aggregate demand in a(n) ________ economy.
A) weaker; open; weaker; open
B) weaker; closed; weaker; closed
C) stronger; open; weaker; open
D) stronger; closed; weaker; open
12) Suppose the Fed purchases Treasury securities. Interest rates in the United States will ________ and
the U.S. dollar will ________ against foreign currencies.
A) decrease; appreciate
B) decrease; depreciate
C) increase; depreciate
D) increase; appreciate
13) If the Fed pursues an expansionary monetary policy, investment in the United States will ________
and net exports will ________.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
14) Suppose the government cuts taxes. We would expect interest rates to ________ and the dollar to
________ in foreign exchange markets.
A) rise; appreciate
B) rise; depreciate
C) fall; depreciate
D) fall; appreciate
15) Following a tax cut by government, domestic investment will ________ and net exports will
________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
16) How will contractionary monetary policy in Japan affect the demand for the yen and the supply of
the yen in the foreign exchange market?
A) The demand for the yen will fall, and the supply of the yen will increase.
B) The demand for the yen will increase, and the supply of the yen will fall.
C) The demand for the yen will fall, and the supply of the yen will fall.
D) The demand for the yen will increase, and the supply of the yen will increase.
17) In an open economy, expansionary monetary policy will cause
A) consumption, investment, and net exports to rise.
B) consumption and investment to rise, but net exports will fall.
C) consumption to rise, but investment and net exports will fall.
D) consumption to fall, but investment and net exports will rise.
18) Which of the following is “crowded out” by higher interest rates that can be the result of
expansionary fiscal policy?
A) consumption
B) private investment
C) net exports
D) All of the above are crowded out by higher interest rates.
19) If the government finances an increase in government purchases with an increase in taxes, which of
the following would you expect to see?
A) an increase in the exchange rate
B) a decrease in the interest rate
C) a decrease in aggregate demand
D) an increase in net exports
20) How does contractionary monetary policy affect net exports in the short run?
A) Contractionary monetary policy increases exports and reduces imports.
B) Contractionary monetary policy reduces exports and increases imports.
C) Contractionary monetary policy increases exports and increases imports.
D) Contractionary monetary policy reduces exports and reduces imports.
21) Which of the following would you expect to decrease both interest rates and exchange rates?
(Assume exchange rates are stated in terms of foreign currency per domestic currency.)
A) contractionary monetary policy
B) expansionary monetary policy
C) contractionary fiscal policy
D) Both B and C will decrease both interest rates and exchange rates.
22) Monetary policy has a ________ effect on aggregate demand in a(n) ________ economy, and fiscal
policy has a ________ effect on aggregate demand in a(n) ________ economy.
A) weaker; open; weaker; open
B) weaker; closed; stronger; closed
C) stronger; open; weaker; closed
D) stronger; closed; weaker; open
23) A decision by foreign central banks to sell their holdings of U.S. Treasury bonds will
A) lower bond prices and interest rates in the United States.
B) increase bond prices and interest rates in the United States.
C) increase bond prices and lower interest rates in the United States.
D) lower bond prices and increase interest rates in the United States.
24) Monetary policy has a greater impact in an open economy than it does in a closed economy.
25) Expansionary fiscal policy should raise the exchange rate of the dollar.
26) Contractionary monetary policy should increase foreign financial investment in the United States.
27) Expansionary monetary policy lowers interest rates and forces a real appreciation of the dollar in
international currency markets.
28) Expansionary fiscal policy crowds out both domestic investment and net exports.
29) Fiscal policy has a greater impact in a closed economy than it does in an open economy.
30) Contractionary monetary policy and expansionary fiscal policy both reduce net exports in an open
economy.
31) Is fiscal policy more or less effective in manipulating aggregate demand in an open economy?
32) How is the impact of contractionary monetary policy different in an open economy than in a closed
economy?
33) How is the impact of expansionary fiscal policy different in an open economy than in a closed
economy?
34) How will an increase in federal government spending without an increase in taxes affect real GDP
and the price level in the short run in a closed economy and in an open economy?
35) How is the impact of expansionary monetary policy different in an open economy than in a closed
economy?
36) Suppose that Federal Reserve policy leads to higher interest rates in the United States. How will this
policy affect real GDP in the short run if the United States is a closed economy, and how will it affect
real GDP in the short run if the United States is an open economy?