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10) Combine the graph showing the interest parity condition and one showing money demand and
supply to demonstrate simultaneous equilibrium in the money market and the foreign exchange market.
How would an increase in the U.S. money supply affect the Dollar/Euro exchange rate and the U.S.
interest rate? Illustrate your answer graphically and explain.
15.6 Money, the Price Level, and the Exchange Rate in the Long Run
1) An economy's long-run equilibrium is
A) the equilibrium that would occur if prices were perfectly flexible.
B) the equilibrium that would occur if prices were perfectly flexible and always adjusted immediately.
C) the equilibrium that would occur if prices were perfectly flexible and always adjusted immediately to
preserve full employment.
D) the equilibrium that would occur if prices were perfectly fixed to preserve full employment.
E) the equilibrium that would occur if prices were perfectly fixed at the full employment point.
2) A permanent increase in a country's money supply
A) causes a more than proportional increase in its price level.
B) causes a less than proportional increase in its price level.
C) causes a proportional increase in its price level.
D) leaves its price level constant in long-run equilibrium.
E) causes an inversely proportional fall in its price level.
3) A change in the level of the supply of money
A) increases the long-run values of the interest rate and real output.
B) decreases the long-run values of the interest rate and real output.
C) has no effect on the long-run values of the interest rate, but may affect real output.
D) has no effect on the long-run values of real output, but may affect the interest rate.
E) has no effect on the long-run values of the interest rate and real output.
4) Changes in the money supply growth rate
A) are neutral in the short run.
B) need not be neutral in the short run.
C) are neutral in the long run.
D) need not be neutral in the long run.
E) affect the real output of the economy.
5) A sustained change in the monetary growth rate will,
A) immediately affect equilibrium real money balances by raising the money interest rate.
B) eventually affect equilibrium nominal money balances by raising the money interest rate.
C) eventually affect equilibrium real money balances by reducing the money interest rate.
D) eventually affect equilibrium real money balances by raising the real interest rate.
E) eventually affect equilibrium real money balances by raising the money interest rate.
6) Money demand behavior may
A) change as a result of demographic trends or financial innovations such as electronic cash-transfer
facilities.
B) change only as a result of demographic trends.
C) change only as a result of financial innovations such as electronic cash-transfer facilities.
D) not change as a result of demographic trends or financial innovations such as electronic cash-transfer
facilities.
E) change as a result of demographic trends but not as a result of financial innovations such as electronic
cash-transfer facilities.
7) Using year-by-year data from 1987-2007 shows that
A) there is a strong positive relation between average Latin American money-supply growth and
inflation.
B) there is a strong negative relation between average Latin American money-supply growth and
inflation.
C) there is a strong positive relation between average Latin American money-supply growth and
deflation.
D) it is difficult to find a strong positive relation between average Latin American money-supply growth
and inflation.
E) there is a weak positive relation between average Latin American money-supply growth and
inflation.
8) Which one of the following statements is the most accurate?
A) A permanent increase in a country's money supply causes a proportional long-run depreciation of its
currency against foreign currencies.
B) A temporary increase in a country's money supply causes a proportional long-run depreciation of its
currency against foreign currencies.
C) A permanent increase in a country's money supply causes a proportional long-run appreciation of its
currency against foreign currencies.
D) A permanent increase in a country's money supply causes a proportional short-run depreciation of its
currency against foreign currencies.
E) A permanent increase in a country's money supply causes a proportional short-run appreciation of its
currency against foreign currencies.
9) The long run effects of money supply change:
A) ambiguous effect on the long-run values of the interest rate or real output, a proportional change in
the price level's long-run value in the opposite direction.
B) proportional effect on the long-run values of the interest rate or real output, a proportional change in
the price level's long-run value in the same direction.
C) no effect on the long-run values of the interest rate or real output, a proportional change in the price
level's long-run value in the same direction.
D) no effect on the long-run values of the interest rate or real output, no change in the price level's long-
run value.
E) ambiguous effect on the long-run values of the interest rate or real output, A disproportional change
in the price level's long-run value in the same direction.
15.7 Inflation and Exchange Rate Dynamics
1) What term means an explosive and seemingly uncontrollable inflation in which money loses value
rapidly and may even go out of use?
A) superinflation
B) stagflation
C) hyperinflation
D) maginflation
E) deflation
2) The most extreme inflationary conditions occurred
A) in Latin America in the 1990s.
B) in Latin America in the 1980s.
C) in Eastern Europe in the 1990s.
D) in Eastern Europe in the 1980s.
E) in Eastern Europe in the 1970s.
3) For main industrial countries such as Japan and the U.S.,
A) there is much less month-to-month variability of the exchange rate, suggesting that price levels are
relatively sticky in the short run.
B) there is much more month-to-month variability of the exchange rate, suggesting that price levels are
relatively sticky in the short run.
C) there is almost the same month-to-month variability of the exchange rate and price levels.
D) it is hard to tell whether month-to-month variability of the exchange rate is similar to changes in
price levels.
E) there is much more month-to-month variability of the exchange rate, suggesting that price levels are
relatively sticky in the long run.
4) Which one of the following statements is the most accurate?
A) There is a lively academic debate over the possibility that seemingly sticky wages and prices are in
reality quite fixed.
B) There is a lively academic debate over the possibility that seemingly sticky wages and prices are in
reality much more sticky than theory assumes.
C) There is a lively academic debate over the possibility that seemingly sticky wages and prices are in
reality quite flexible.
D) There is no debate over the possibility that wages and prices are sticky in the long run.
E) There is no debate over the possibility that wages and prices are sticky in the short run.
5) During hyperinflation, exploding inflation causes real money demand to
A) fall over time, and this additional monetary change makes money prices rise even more quickly than
the money supply itself rises.
B) increase over time, and this additional monetary change makes money prices rise even more quickly
than the money supply itself rises.
C) fall over time, and this additional monetary change makes money prices decrease even more quickly
than the money supply itself rises.
D) increase over time, and this additional monetary change makes money prices decrease even more
quickly than the money supply itself rises.
E) fall over time, and this additional monetary change makes money prices decrease even less quickly
than the money supply itself rises.
6) In a classic paper, Columbia University economist Phillip Cagan drew the line between inflation and
hyperinflation at an inflation rate of
A) 50 percent per month.
B) 10 percent per month.
C) 20 percent per month.
D) 5 percent per month.
E) 25 percent per month.
7) In a classic paper, Columbia University economist Phillip Cagan drew the line between inflation and
hyperinflation at an inflation rate of
A) more than 120 percent per year.
B) more than 100 percent per year.
C) more than 200 percent per year.
D) more than 12,000 percent per year.
E) more than 1,000 percent per year.
8) In a world where the price level could adjust immediately to its new long-run level after a money
supply increase,
A) The dollar interest rate would increase because prices would adjust immediately and prevent the
money supply from rising.
B) The dollar interest rate would fall because prices would adjust immediately and prevent the money
supply from rising.
C) The dollar interest rate would fall because prices would adjust immediately and prevent the money
supply from decreasing.
D) The dollar interest rate would decrease because prices would adjust immediately and prevent the
money supply from decreasing.
E) The dollar interest rate would fall because prices would not be able to prevent the money supply from
rising.
9) After a permanent increase in the money supply,
A) the exchange rate overshoots in the short run.
B) the exchange rate overshoots in the long run.
C) the exchange rate smoothly depreciates in the short run.
D) the exchange rate smoothly appreciates in the short run.
E) the exchange rate remains the same.
10) A change in the money supply creates demand and cost pressures that lead to future increases in the
price level from which main sources?
I. Excess demand for output and labor
II. Inflationary expectations
III. Raw materials prices
A) I
B) II
C) II and III
D) I and II
E) I, II, and III
11) What year did the Bolivian government introduce a stabilizing plan to end hyperinflation?
A) 1983
B) 1984
C) 1985
D) 1986
12) Which of the following can help to explain why higher inflation may lead to currency appreciations?
A) The interest rate is not the prime target of monetary policy.
B) Most central banks adjust their policy interest rates expressly so as to keep inflation in check.
C) Central banks increase the money supply leading to overshooting of the exchange rate.
D) Inflation will increase the purchasing power of a currency.
E) The world market does not adjust their currency trade to reflect inflation.
13) Which of the countries below are inflation targeting?
A) Japan
B) U.S.
C) Canada
D) Mexico
E) Nicaragua
14) Michael Woodford says the following is an advantage of interest-rate instruments for central banks:
A) Conduct monetary policy without inflation.
B) Conduct monetary policy even if checking deposits pay interest at competitive rates.
C) Conduct monetary policy without government approval.
D) Conduct monetary policy with consumers in mind.
E) Conduct monetary policy with workers in mind.
15) Inflation targeting was initiated by which central bank in 1989?
A) U.S.
B) Japan
C) Canada
D) New Zealand
E) U.K.
16) "Although the price levels appear to display short-run stickiness in many countries, a change in the
money supply creates immediate demand and cost pressures that eventually lead to future increase in the
price level." Discuss.
17) Explain the effects of a permanent increase in the U.S. money supply in the short run and in the long
run. Assume that the U.S. real national income is constant.
18) Explain the exchange rate over-shooting hypothesis.
19) Using figures for both the short run and the long run, show the effects of a permanent increase in the
U.S. money supply. Try to line up your figures to the short and long run equilibria side by side. Assume
that the U.S. real national income is constant.
20) Using 4 different figures, plot the time paths showing the effects of a permanent increase in the
United States money supply on:
(a) U.S. Money supply
(b) The dollar interest rate.
(c) The U.S. price level
(d) The dollar/euro exchange rate
