10.4 The Real Exchange Rate
1) Suppose that the nominal exchange rate between the U.S. dollar and the Mexican peso is 0.10
dollars per peso. If Mexico’s inflation is 10 percent and the United States’ inflation is 0 percent,
from the U.S. point of view, the real exchange rate
A) appreciates to 0.11 dollars per peso.
B) depreciates to 0.11 dollars per peso.
C) appreciates to 0.09 dollars per peso.
D) depreciates to 0.09 dollars per peso.
2) Suppose that the nominal exchange rate between the U.S. dollar and the Canadian dollar is
0.75 U.S. dollars per Canadian dollar. If Canada’s rate of inflation is 0 percent and the U.S. rate
is 10 percent, then the real exchange rate for the U.S. dollar will
A) appreciate by about 9 percent.
B) appreciate by 10 percent.
C) depreciate by about 9 percent.
D) depreciate by 10 percent.
3) According to purchasing power parity, which of the following is FALSE about an overvalued
dollar compared to the Japanese yen?
A) U.S. merchants would be motivated to import more Japanese goods.
B) Japanese merchants would tend to export more to the United States.
C) Prices in the United States would tend to fall.
D) Over the long term, the exchange rate would fall.
4) The real exchange rate is defined as
A) the market exchange rate adjusted for price differences.
B) the purchasing power parity exchange rate.
C) the exchange rate that causes interest parity to hold.
D) the exchange rate that exists in major currency centers.
5) If the nominal exchange rate does not change, but U.S. prices rise, the real exchange rate has
________, and U.S. imports are likely to ________.
A) increased; rise
B) increased; fall
C) decreased; rise
D) decreased; fall
6) When the purchasing power of currencies is the same,
A) interest parity holds.
B) currencies cannot change in value
C) the real exchange rate is equal to the nominal exchange rate.
D) interest rates are the same.
7) Holding nominal exchange rates constant, if inflation in Europe exceeds inflation in the
United States,
A) the real exchange rate ($/€) will rise, and the euro will buy more in the U.S.
B) the real exchange rate ($/€) will rise, and the euro will buy less in the U.S.
C) the real exchange rate ($/€) will fall, and the euro will buy more in the U.S.
D) the real exchange rate ($/€) will fall, and the euro will buy less in the U.S.
8) What matters most to importers and exporters is the nominal exchange rate.
9) A rise in the real exchange rate represents an increase in the purchasing power of the home
currency.
10) A tourist going to Europe would be happy if the real exchange rate ($/€) increased.
11) A rise in the nominal exchange rate ($/€) represents a depreciation of the dollar relative to
the euro, but a rise in the real exchange rate ($/€) represent an appreciation of the dollar. Explain
why this is true.
12) If nominal exchange rates do not change, an increase in the U.S. price level relative to the
foreign price level represents a real appreciation of the dollar. However, if nominal exchange
rates can change, is an increase in U.S. inflation relative to foreign inflation likely to cause
appreciation of the dollar in the short run?
1) Which of the following is true?
A) If an exchange rate is allowed to vary across a fixed basket of currencies, it is called a hard
peg.
B) If an exchange rate is not allowed to vary against the target currency, it is called a soft peg.
C) If an exchange is only allowed to fluctuate within a set band, it is considered to be a flexible
exchange rate system.
D) A soft peg is when a currency’s exchange rate is only allowed to fluctuate within a set band.
2) Which of the following defines a flexible exchange rate?
A) An exchange rate determined by the market
B) An exchange rate that fluctuates within a set band
C) An exchange rate that is not allowed to vary
D) An exchange rate that is backed by gold
3) Which of the following defines a hard peg?
A) An exchange rate determined by the market
B) An exchange rate that fluctuates within a set band
C) An exchange rate that is not allowed to vary
D) An exchange rate that is backed by gold
4) Which of the following defines a soft peg?
A) An exchange rate determined by the market
B) An exchange rate that fluctuates within a set band
C) An exchange rate that is not allowed to vary
D) An exchange rate that is backed by gold
5) Under a pure gold standard,
A) exchange rates float most of the time.
B) money is worth more than under other systems.
C) nations must buy and sell gold to settle international obligations.
D) there is no inflationary pressure.
6) Which of the following is not a true statement about the Bretton Woods system?
A) The value of the dollar was fixed in terms of gold.
B) Other currencies fixed values in terms of the dollar.
C) The U.S. was able to increase its money supply easily.
D) Trade deficits were eliminated.
7) Soft pegs that are periodically adjusted are called
A) crawling pegs.
B) hard pegs.
C) snakes.
D) managed floats.
8) Under a gold standard, countries should
A) keep the supply of their domestic money constant.
B) keep the supply of their domestic money fixed in proportion to their gold holdings.
C) keep the supply of foreign exchange less than their domestic money supply.
D) restrict the demand for foreign goods.
9) Under a fixed exchange standard, if the domestic demand for foreign exchange increases,
A) the central monetary authority must meet the demand out of its reserves.
B) the central monetary authority must increase the supply of domestic money.
C) the fixed exchange standard will breakdown.
D) inflation will increase.
10) The Bretton Woods exchange rate system was an example of a
A) managed float.
B) pure gold standard.
C) modified gold standard.
D) floating exchange rate system.
11) The Smithsonian Agreement of 1971 was hailed by President Nixon as a fundamental
reorganization of the international monetary system. In fact, what it accomplished was
A) the revaluation of the dollar.
B) the devaluation of the dollar.
C) an increase of the gold content of the dollar.
D) the elimination of gold backing for the dollar.
12) The biggest disadvantage of a fixed exchange rate is the
A) increased probability of high inflation.
B) tradeoff between supporting the exchange rate and adjusting the trade balance.
C) tradeoff between supporting the exchange rate and maintaining economic growth.
D) tradeoff between supporting the exchange rate and maintaining a balanced budget.
13) The majority of countries in the world have some type of fixed exchange rate system.
14) Economists usually favor a return to the gold standard.
15) If a currency has a fixed exchange rate, it is not subject to the forces of supply and demand.
16) When did major currencies begin floating against each other, ending the Bretton Woods
system?
17) Explain the three rules that countries must follow to maintain a gold standard.
18) Explain the three rules that countries must follow to maintain a gold standard.
19) What are the differences and similarities between a depreciation and devaluation of a
currency?
1) A single currency area requires
A) mobile labor and synchronized business cycles.
B) immobile labor and synchronized business cycles.
C) immobile labor and mobile capital.
D) mobile labor and unsynchronized business cycles.
2) Which of the following is NOT one of the determinants of the gains of adopting a single
currency?
A) A well-synchronized business cycle involving all member countries
B) The possibility of factors of production to freely move across borders
C) The willingness and ability of member countries to design policies to address regional
imbalances that may develop
D) Widening the common market by allowing other countries to join
3) The traditional view of fixed rate systems was that
A) they improved inflation but were worse for growth.
B) they improved stability but were worse for inflation.
C) they improved inflation but worsened stability.
D) they improved growth but worsened inflation.
4) A reason why fixed exchange rate systems might lower growth is that
A) inflation may be higher.
B) monetary policy cannot be used.
C) they are more risky.
D) they deter international trade.
5) Economic research using data from the 1990s has shown that
A) floating rate systems are better for economic growth.
B) fixed rate systems are better for economic growth.
C) gold standards are better for economic growth.
D) there is no clear relationship between the exchange rate system and growth.
6) When most shocks originate in the monetary sector, it is generally better to have
A) a flexible rate system.
B) a fixed rate system.
C) a gold standard.
D) a managed float.
7) When most shocks to the economy are external, it is generally better to have
A) a flexible rate system.
B) a hard peg.
C) a soft peg.
D) a crawling peg.
8) Exchange rate pegs are popular with developing countries because they increase credibility.
9) When an economy is closely tied to another, larger economy, floating exchange rates are
usually desirable.
10) Which type of exchange rate system minimizes external shocks to an economy?
11) How is dollarization different from monetary union?
12) Currently the NAFTA nations do not meet the conditions for an optimal currency area. What
are the two main reasons why?
13) Why might a group of countries wish to have a common currency? Explain four reasons.
14) Explain Mundell’s four conditions for adopting a single currency.
15) What are the disadvantages of adopting a single currency? Explain.