Chapter 19
Exchange Rate Policy and the Central Bank
Multiple-Choice Questions
1. Within the United States, every city has:
a. a fixed exchange rate with every other city.
b. a floating exchange rate with every other city.
c. an independent monetary policy.
d. their own currency board.
2. If capital flows freely between countries and a country has a fixed exchange rate, one thing
you know is that the country:
a. exports more than it imports.
b. must have ample gold reserves.
c. cannot have a discretionary monetary policy.
d. must be running large trade deficits
3. Purchasing power parity implies:
a. a basket of goods should sell for the same price in all countries, even if trade barriers exist.
b. a basket of goods will sell for the same price in all countries as long as there are no trade
barriers is a free flow of capital across borders.
c. a basket of goods cannot sell for the same price in different countries due to the different
wage rates.
d. as long as all goods and services are traded freely across international boundaries, one
unit of domestic currency should buy the same basket of goods anywhere in the world.
4. If inflation in country A exceeds inflation in country B, purchasing power parity implies that:
a. the currency of country B should depreciate relative to the currency of country A.
b. the inflation rate in country B will rise to match the inflation rate in country A.
c. the currency of country A will depreciate relative to the currency of country B.
d. the inflation rate in country A will fall to match the inflation rate in country B.
5. If inflation in country A exceeds inflation in country B, we can express the percentage change
in the units of currency of country A per unit of currency of country B as:
a. the inflation rate in country B – the inflation rate in country A.
b. the inflation rate in country A – the inflation rate in country B.
c. the inflation rate in country A times the inflation rate in country B.
d. the inflation rate in country A divided by the inflation rate in country B.
6. If the inflation rate in country A is 3.5% and the inflation rate in country B is 3.0%, we should
expect the percentage change in the number of units of country A’s currency per unit of country
B’s currency to be:
a. +0.5%.
b. -0.5%.
c. +16.7%.
d. +6.5%.
7. If a U.S. dollar currently purchases 1.3 Canadian dollars and the inflation rate in Canada over
the next year is 5 percent while it is 2 percent in the U.S., we should expect a U.S. dollar to
purchase:
a. 1.365 Canadian dollars.
b. 1.262 Canadian dollars.
c. 1.300 Canadian dollars.
d. 1.339 Canadian dollars.
8. Assuming the free flow of capital across borders, if country A wants to fix its exchange rate
with country B, then:
a. country A’s inflation rate will have to match country B‘s.
b. country A’s monetary policy must be conducted so the inflation rate in country A matches the
inflation rate in country B.
c. country A’s monetary policy will not be able to be used to address domestic issues.
d. all of the answers given are correct.
9. Assuming the free flow of capital across borders, which of the following statements is most
correct?
a. A central bank can have both a fixed exchange rate and an independent inflation policy.
b. A central bank cannot have both a fixed exchange rate and an independent inflation policy.
c. The central banks of most industrialized countries focus on fixed exchange rates.
d. While most central banks of industrialized countries favor fixing exchange rates, their primary
concern is on domestic inflation.
10. Purchasing power parity is a good theory of explaining exchange rate behavior:
a. over very short periods.
b. over periods lasting six to twelve months.
c. over very long periods, such as decades.
d. over both long and short periods.
11. In the short run, a country‘s exchange rate is determined by:
a. monetary policy.
b. purchasing power parity.
c. the domestic inflation rate.
d. supply and demand.
12. International capital mobility:
a. contributes to the rigidity of exchange rates.
b. contributes to the equalization of expected returns across countries.
c. eliminates arbitrage opportunities.
d. makes interest rates equal across countries.
13. If the bonds of two different countries are identical, their expected returns will:
a. be equal if capital flows freely internationally.
b. always be equal.
c. be equal only if the exchange rate between the two countries is fixed.
d. be equal only if the inflation rate is the same in each country.
14. When arbitrage occurs across countries with flexible exchange rates and when the bonds in
each country are identical and there are no barriers to capital flows:
a. the interest rates on the bonds will be identical.
b. the prices of the bonds will be identical.
c. the inflation rates in each country will be identical.
d. none of the answers provided is correct.
15. When arbitrage occurs across countries with a flexible exchange rate and when the bonds in
each country are identical and there are no barriers to capital flows then the:
a. interest rates on the bonds will be identical.
b. expected return on the bonds will be identical.
c. inflation rates in each country will be identical.
d. prices of the bonds will be identical.
16. Let if be the interest rate being paid on a foreign bond, and let i be the interest rate being
paid for a domestic bond; let P be the price of the domestic bond and let Pf be the price of the
foreign bond. If exchanges rates are fixed and the bonds are equal in terms of risk:
a. if = i.
b. P = Pf times units of domestic currency/unit of foreign currency.
c. the expected return from the foreign bond = the expected return from the domestic bond.
d. all of the answers given are correct.
17. In the long run, a country‘s exchange rate is determined by:
a. domestic monetary.
b. purchasing power parity.
c. the domestic inflation rate.
d. supply and demand.
18. Consider the following: an investor in the U.S. is pondering a one-year investment. She can
purchase a domestic bond for $1,000 that has an interest rate of i or she can purchase a bond in
England for 1,500 British pounds (£) that pays an interest rate of if. The current exchange rate is
$1.50/£ . She considers the bonds to be of equal risk. If i = if, the expected returns are not
equal. What do you know?
a. The exchange rate is fixed between the U.S. and Britain
b. The bonds initially sold for different prices
c. Arbitrage doesn’t work
d. The exchange rate must be flexible
19. Which of the following statements is incorrect?
a. A country cannot be open to international capital flows, control its domestic interest rate and
fix its exchange rate.
b. A country can be open to international capital flows and control its own domestic interest rate
but it can’t fix its exchange rate.
c. A country can be open to international capital flows, control its domestic interest rate, and fix
its exchange rate.
d. A country can be open to international capital flows and fix its exchange rate but
could not also control its own domestic interest rate.
20. The United States would be characterized as having:
a. a controlled domestic interest rate, a closed capital market and a flexible exchange rate.
b. a controlled domestic interest rate, an open capital market and a flexible exchange rate.
c. no control over the domestic interest rate, an open capital market and a flexible exchange rate.
d. a controlled domestic interest rate, an open capital market and a fixed exchange rate.
21. Most economists view capital controls:
a. unfavorably.
b. unfavorably, emphasizing their harmful effects on developing countries.
c. favorably, since this is the main way for countries to exploit their comparative advantage.
d. favorably, since having them makes capital markets more efficient.
22. Capital controls:
a. can be controls on capital
infl
ows.
b. can only be controls on capital outflows.
c. can be controls on capital inflows or outflows.
d. must be controls on both capital inflows and outflows in order to be effective.
23. During the 1990s, the country of Chile required foreigners wishing to invest in the country
to make a one-year, zero-interest deposit in the Chilean central bank equal to at least 20 percent
of the investment. This is an example of:
a. a capital outflow control.
b. a capital inflow control.
c. an exchange rate mechanism.
d. a currency board.
24. Which of the following would be an example of a capital outflow control?
a. Mexico limiting the number of U.S. dollars an American can bring into the country
b. Mexico excludes foreigners from purchasing short-term debt
c. Mexico limiting the number of pesos its citizens can take out of the country
d. All of the answers given would be examples of capital outflow
control
s
25. If domestic residents are restricted in their ability to purchase foreign assets then their
government is imposing:
a. controls on capital
infl
ows.
b. controls on capital outflows.
c. controls on both capital inflows and outflows.
d. fixed exchange rates.
26. If foreigners are restricted in their ability to sell investments in a country then that
government is imposing:
a. controls on capital
infl
ows.
b. controls on capital outflows.
c. controls on both capital inflows and outflows.
d. fixed exchange rates.
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27. If foreigners are restricted in their ability to buy investments in a country then that
government is imposing:
a. controls on capital
infl
ows.
b. controls on capital outflows.
c. controls on both capital inflows and outflows.
d. fixed exchange rates.
28. A country announces capital outflow controls that will take effect in three months. This
announcement will likely:
a. stabilize the country‘s exchange rate.
b. attract significant amounts of foreign investors.
c. result in a significant appreciation of the country‘s currency.
d. result in a significant depreciation in the country’s currency.
29. A country that frequently uses capital controls:
a. increases the risk for foreign investors.
b. decreases the risk for foreign investors.
c. should see lower interest rates on its domestic bonds and lower prices.
d. will attract more investment.
30. If the Fed desired to fix the euro/dollar exchange rate, they would have to:
a. get the European Central Bank to also agree to fixed exchange rates.
b. maintain ample reserves of dollars.
c. be willing to exchange dollars for euros whenever anyone asked.
d. impose capital controls.
31. An open-market purchase of foreign bonds to increase a central bank’s international
reserves:
a. increases the central bank’s liabilities and assets.
b. decreases the central bank’s assets and liabilities.
c. increases the central bank’s assets but decreases its liabilities.
d. increases the central bank’s liabilities and decreases its assets.
32. If the Fed decides to maintain a fixed euro/dollar exchange rate when they purchase euros:
a. they increase the number of dollars.
b. downward pressure is put on domestic interest rates.
c. the domestic money supply increases.
d. all of the answers given are correct.
33. If the Fed decides to maintain a fixed euro/dollar exchange rate when they sell euros:
a. there will be pressure on domestic interest rates to increase.
b. the domestic money supply will increase.
c. this will increase banking system reserves.
d. they will have to impose capital controls.
34. If the Fed decides to control the euro/dollar exchange rate:
a. they will also have to control the domestic interest rate.
b. they will have to control the amount of banking system reserves.
c. the market will determine the interest rate.
d. they will have to control the domestic rate of inflation or it won’t work.
35. Reserves in the banking system will increase if the Fed:
a. buys euros or sells dollars.
b. sells euros or buys dollars.
c. sells euro-dominated bonds and exchanges the euros for dollars.
d. sells euro-dominated bonds and keeps the euros from the sale.
36. The Fed holds its euro reserves primarily in the form of:
a. euro currency.
b. a weighted portfolio of European government bonds.
c. German government bonds.
d. international mutual funds.
37. If the Fed were to enter the foreign exchange market and purchase euros, the impact on
domestic banking reserves would be:
a. the opposite of what it would be with an open market purchase.
b. domestic banking reserves would decrease.
c. the same as it would be with an open market purchase.
d. uncertain.
38. The impact on the foreign exchange market for dollars resulting from the Fed selling
euros will be:
a. a decrease in the demand for dollars.
b. a decrease in the supply of dollars.
c. an increase in the supply of dollars.
d. a decrease in the interest rate in the U.S.
39. If interest rates in the U.S. increases relative to interest rates in Europe:
a. the demand for dollars on the foreign exchange market would increase.
b. the supply of euros on the foreign exchange market would increase.
c. the price of U.S. assets should increase.
d. all of the answers given are
correct.
40. A foreign exchange intervention by a central bank affects the value of a country’s
currency if it:
a. alters banking system reserves.
b. leaves domestic interest rates unchanged.
c. results in a fixed exchange
rate.
d. alters banking system reserves and it changes domestic interest rates.
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41. Any central bank policy that influences the domestic interest rate will:
a. have no effect on the exchange rate if exchange rates are flexible.
b. have an effect on the exchange rate.
c. not impact the supply of and demand for the domestic currency if exchange rates are flexible.
d. be compatible with fixed exchange rates.
42. Assume that the Fed performs a foreign exchange intervention in which it does nothing
except buy German government bonds. One result of this will be that:
a. the dollar depreciates.
b. the euro depreciates.
c. both the dollar and the euro depreciate.
d. the dollar appreciates and the euro depreciates.
43. Which of the following statements is incorrect?
a. A foreign exchange intervention affects the value of a country‘s currency by changing
domestic interest rates.
b. Any central bank policy that influences the domestic interest rate will affect the exchange rate.
c. Higher U.S. interest rates would likely result in an appreciation of the U.S. dollar.
d. Sterilized changes in foreign exchange reserves alter a country’s monetary base.
44. A sterilized foreign exchange intervention would:
a. alter the asset side of a central bank’s balance sheet but leave the domestic monetary base
unchanged.
b. alter the liability side of the central bank’s balance sheet but leave the asset side unchanged.
c. leave the central bank’s balance sheet unchanged.
d. not alter the central bank’s holdings of international reserves.
45. If the Fed were to purchase euros for dollars and at the same time sell U.S. Treasury
securities in the open market, this would be an example of:
a. an unsterilized foreign exchange intervention.
b. the Fed not changing their balance sheet at all.
c. a sterilized foreign exchange intervention.
d. the Fed altering the domestic monetary base.
46. A foreign exchange intervention that alters the domestic monetary base is:
a. sterilized.
b. unsterilized.
c. not likely to change domestic interest rates.
d. impossible.
47. A foreign exchange intervention that does not alter the domestic monetary base is:
a. sterilized.
b. unsterilized.
c. likely to change domestic interest rates.
d. impossible.
48. Which of the following statements is most correct?
a. A sterilized foreign exchange intervention will alter the composition of a central bank’s assets
and alter commercial bank reserves.
b. A sterilized foreign exchange intervention will not alter the composition of a central bank’s
assets.
c. An unsterilized foreign exchange intervention will alter commercial bank reserves.
d. A sterilized foreign exchange intervention will leave the central bank’s holdings of foreign
reserves unchanged.
49. In September of 2000, the Federal Reserve Bank of New York sold dollars in exchange for
euro. To keep the federal funds rate on target, the Open Market desk:
a. sold U.S. Treasury bonds.
b. bought U.S. Treasury bonds.
c. bought dollars.
d. sold dollars.
50. Suppose that you purchase a Korean government bond and the number of won needed to
purchase one dollar increases. Your return on the bond:
a. decreases by the amount of the dollar’s appreciation.
b. decreases by more than the amount of the dollar’s appreciation.
c. decreases by less than the amount of the dollar’s appreciation.
d. increases by the amount of the dollar’s appreciation.
51. A U.S. resident purchases a bond issued by the Canadian government. If the Canadian dollar
appreciates relative to the U.S. dollar over the term of the bond, the U.S. investor will:
a. see a higher return on her investment as a result.
b. see a lower return on her investment as a result.
c. not see her return affected since exchange rates are flexible.
d. none of the answers provided is correct.
52. An advantage of fixed exchange rates for a country that suffers from bouts of high inflation
is:
a. it makes imports less expensive.
b. it establishes a credible low inflation policy.
c. it unties policymakers’ hands so they can alter the reserves of the banking system as needed.
d. policymakers will have increased control over domestic interest rates.
53. A fixed exchange rate policy:
a. decreases central bank policy accountability and transparency.
b. strengthens domestic interest rate policy.
c. will likely make domestic inflation more volatile.
d. imports monetary policy.
54. When Argentina fixed the exchange rate of their peso to the U.S. dollar, one outcome was:
a. Argentinean central bankers regained control of their domestic interest rate.
b. Argentinean central bankers were finally able to focus their attention on domestic monetary
policy.
c. Argentinean central bankers effectively gave control of their domestic interest rate to the
FOMC.
d. Argentineans began using the U.S. dollar for all of their transactions.
55. Fixing an exchange rate between two countries makes the most sense when:
a. the countries macroeconomic fluctuations are positively correlated.
b. the countries macroeconomic fluctuations are negatively correlated.
c. the countries’ macroeconomic fluctuations are uncorrelated.
d. one country has a lot of international reserves and the other doesn’t.
56. All of the following are associated with a fixed exchange rate policy except:
a. sacrificing control of the domestic inflation rate.
b. higher import prices.
c. the need to maintain ample international reserves.
d. it means importing monetary policy.
57. A country with a fixed exchange rate policy and free cross-border capital flows that is
experiencing an economic slowdown will find:
a. their central bank will reduce the domestic interest rate in order to fend off the slowdown.
b. their currency will depreciate to stimulate exports.
c. their corporate equities will become more attractive to foreign investors.
d. monetary policy in not available as an economic stabilization tool.
58. A speculative attack on a country with a fixed exchange rate occurs when:
a. financial market participants believe the government will have to devalue its currency.
b. financial market participants believe the government has a large excess of international
reserves.
c. financial market participants believe the currency is undervalued.
d. the country converts its gold reserves into foreign exchange.
59. In 1997, there was a speculative attack on the Thai baht. This resulted from the:
a. belief by speculators that the Thai central bank had an oversupply of U.S. dollar reserves.
b. belief by speculators that the Thai central bank didn’t have sufficient U.S. dollar reserves to
maintain the current fixed rate.
c. revelation that the Thai central bank had converted its gold reserves into foreign exchange.
d. overthrow of the Thai president and the central bank.
60. Speculative attacks:
a. can only result from irresponsible fiscal policy.
b. can always be stopped by the country‘s central bank if they act quickly.
c. can be triggered even when domestic policymakers are acting responsibly.
d. are illegal, and if caught, speculators are assessed large fines.
61. Which of the following statements is most correct?
a. A fixed exchange rate policy is a lack of a monetary policy.
b. A fixed exchange rate policy is appropriate for a country that lacks a central bank.
c. A fixed exchange rate policy is only appropriate for countries with little international reserves.
d. A fixed exchange rate policy is a monetary policy.
62. One reason a country would be better off fixing its exchange rate is if:
a. it has a strong reputation for controlling inflation on its own.
b. it lacks ample foreign exchange reserves.
c. it is well-integrated with the economy of the country to whose currency its currency is fixed.
d. its own macroeconomic characteristics are inversely correlated with the macroeconomic
characteristics of the country to whose currency its currency is fixed.
63. A country that suffers from bouts of high inflation and wants to fix its exchange rate should
tie its currency to the currency of a:
a. country with a strong reputation for low inflation.
b. larger country.
c. country with similar inflation performance.
d. country that is still on the gold standard.