fixed exchange rate.
10) Define devaluation and use a figure to show the effect of a currency devaluation on the economy.
11) Please use a figure to discuss whether or not a devaluation under a fixed exchange rate has the same
long-run effect as a proportional increase in the money supply under a floating rate.
18.6 Managed Floating and Sterilized Intervention
1) Imperfect asset substitutability assumes:
A) the returns on foreign and domestic currency bonds are the same.
B) the returns on foreign and domestic currency are unrelated.
C) the returns on foreign and domestic currency are not influenced by risk.
D) sterilized intervention proves to be unproductive.
E) the returns on foreign and domestic currency are different, but both are influenced by risk.
2) Which of the following is not accurate? After introducing the Real as its new currency in 1994, Brazil
A) lost competitiveness in foreign markets since the Real experienced a real appreciation.
B) experienced high domestic interest rates.
C) reduced its annual rate of inflation.
D) experienced bank failures.
E) raised the foreign reserves in its central bank
3) In 1999, following the failure of a $40 billion IMF stabilization plan, Brazil
A) was forced to revalue the Real.
B) experienced an economic boom.
C) was forced to devalue the Real.
D) saw its currency become overvalued.
E) received another loan from the IMF worth $86 billion.
4) Perfect asset substitutability is the assumption that
A) the foreign exchange market is in equilibrium only when expected returns on domestic assets are
greater than returns on foreign currency bonds.
B) the foreign exchange market is in equilibrium only when expected returns on foreign currency bonds
are greater than returns on domestic assets.
C) the foreign exchange market is in equilibrium only when expected returns on all assets are negative.
D) the foreign exchange market is in equilibrium only when expected returns on domestic assets are
equal to returns on foreign currency bonds.
E) the foreign exchange market is in equilibrium only when domestic assets are risk-free.
5) Imperfect asset substitutability exists
A) when it is possible for the expected returns on two assets to be different.
B) when the expected returns on two assets are the same.
C) only when one asset is foreign and the other is domestic.
D) when there is risk in the foreign exchange market.
E) when assets are liquid.
6) The interest parity condition can be written as
A) R = R – (Ee – E)/E.
B) R = R + (Ee – E)/E.
C) R = R2 – (Ee – E)/E.
D) R = R /(Ee – E).
E) R = R + (Ee + E)/E.
7) When domestic and foreign currency bonds are imperfect substitutes, the domestic interest rate (R)
can be written as
A) R = R – (Ee – E)/E + ρ.
B) R = R – (Ee – E)/E.
C) R = R + (Ee – E)/E + ρ.
D) R = R – (Ee + E)/E + ρ.
E) R = R – (Ee – E)ρ.
8) In the interest rate parity condition with imperfect substitutes and a risk premium of ρ
A) an increased stock of domestic government debt will raise the difference between the expected
returns on domestic and foreign currency bonds.
B) a decreased stock of domestic government debt will raise the difference between the expected returns
on domestic and foreign currency bonds.
C) an increased stock of domestic government debt will reduce the difference between the expected
returns on domestic and foreign currency bonds.
D) an increased stock of domestic government debt will have no effect on the difference between the
expected returns on domestic and foreign currency bonds.
E) a decreased stock of domestic government debt will have no effect on the difference between the
expected returns on domestic and foreign currency bonds.
9) The signaling effect of foreign exchange intervention
A) never has any effect on exchange rates.
B) can alter the market’s view of exchange rates independent from the stance of monetary and fiscal
policies.
C) cannot cause an immediate exchange rate change when bonds denominated in different currencies are
perfect substitutes.
D) never leads to actual changes in monetary or fiscal policy.
E) can alter the market’s view of future monetary policies and cause an immediate exchange rate change.
10) Please describe in detail a self-fulfilling currency crisis.
11) Describe some of the causes of the Brazilian 1998-1999 balance of payments crisis.
12) Use a figure to explain how a balance of payments crisis and its hand in capital flight.
18.7 Reserve Currencies in the World Monetary System
1) Briefly describe two systems for fixing the exchange rates of all currencies against each other and the
time periods in which they were used.
2) This question concerns the mechanism of a reserve currency standard.
Two countries, X and Y, have two currencies, x and y, fixed to the reserve currency, the U.S. dollar.
Suppose the exchange rate between x and the U.S. dollar is 3x per dollar. Suppose the exchange rate
between y and the U.S. dollar is 5y per dollar. Please explain (using numbers) the mechanism if the x-y
exchange rate was 0.5 x per y.
3) This question concerns the mechanism of a reserve currency standard.
Two countries, X and Y, have two currencies, x and y, fixed to the reserve currency, the U.S. dollar.
Suppose the exchange rate between x and the U.S. dollar is 3x per dollar. Suppose the exchange rate
between y and the U.S. dollar is 5y per dollar. Please explain (using numbers) the mechanism if the x-y
exchange rate was 0.8 x per y.
4) Please show how the country whose currency is the reserve currency can use monetary policy for
macroeconomic stabilization. In particular, explain the result if that country doubled its domestic money
supply.
18.8 The Gold Standard
1) From 1837 and up until the Civil War, the United States adhered to a
A) gold standard.
B) silver standard.
C) bimetallic standard.
D) bronze standard.
E) copper standard.
2) Imperfect asset substitutability assumes:
A) the returns on foreign and domestic currency bonds are the same.
B) the returns on foreign and domestic currency are unrelated.
C) the returns on foreign and domestic currency are not influenced by risk.
D) Sterilized intervention proves to be unproductive.
E) the returns on foreign and domestic currency are different, but both are influenced by risk.
3) Assuming perfect asset substitutability, can sterilized intervention by the central bank be effective?
Please discuss.
4) Does the signalling effect of foreign exchange intervention support or refute the claim that assets
cannot be perfect substitutes if sterilized intervention is going to have any effect? Please explain.
5) Briefly discuss the main advantage of the bimetallic standard over the gold standard.
6) Please list the drawbacks of the gold standard.
7) Describe the mechanism which would take place if the Bank of England decides to increase its money
supply by purchasing domestic assets under the gold standard.
8) Please briefly describe what is meant by a gold exchange standard.
9) Use a figure to show the effect of a sterilized central bank purchase of foreign assets under the
imperfect asset substitutability assumption.
10) Assume that initially, the risk premium, ρ = 0 and that the domestic and foreign interest rates are
given by R = .06, R* = .05. Suppose that the risk premium depends linearly on the difference between
domestic government debt, B, and domestic assets of the central bank, A, i.e.
ρ = ρ(B–A)
Find the new domestic interest rate if a sterilized purchase of foreign assets adjusts A s.t.
(a) B – A = -.01/ ρo
(b) B – A = .01/ ρo
(c) B – A = .03/ ρo
11) Assume that initially, the risk premium, ρ = 0 and that the domestic and foreign interest rates are
given by R = .06, R* = .05. Suppose that the risk premium depends linearly on the difference between
domestic government debt, B, and domestic assets of the central bank, A, i.e.
ρ = ρ(B–A)
How much will the central bank have to reduce domestic assets A s.t. the domestic interest rate will
increase by (a) 1% (b) 4%?
12) Under the gold standard, if the dollar price of gold is pegged at $35 per ounce and the euro price of
gold is pegged at 12 euro per ounce, what is the dollar/euro exchange rate?
13) Under the gold standard, if the dollar price of gold is pegged at $35 per ounce and the dollar/euro
exchange rate is set at $2.40 per euro, what must the euro price of gold be pegged at?
14) From the figure below, please provide an explanation for the large growth rate of international
reserves held by developing countries and the sharp decline in the 1980s.
18.9 Appendix 1 to Chapter 18: Equilibrium in the Foreign Exchange Market
with Imperfect Asset Substitutability
1) If assets are imperfect substitutes, then an increase in the amount of domestic currency bonds held by
the public will ________ the risk premium and ________ the amount of domestic currency bonds held
by the central bank.
A) increase; leave unchanged
B) increase; decrease
C) increase; increase
D) decrease; decrease
E) leave unchanged; decrease
2) If assets are imperfect substitutes, then a decrease in the amount of domestic currency bonds held by
the public will ________ the risk premium and ________ the amount of domestic currency bonds held
by the central bank.
A) decrease; leave unchanged
B) increase; decrease
C) increase; increase
D) decrease; decrease
E) leave unchanged; decrease
18.10 Appendix 2 to Chapter 18: The Timing of Balance of Payments Crises
1) Balance of payments crises under fixed exchange rates occur because of
A) government policies that are inconsistent with fixed exchange rates.
B) punitive currency wars.
C) global inflation and trade imbalances due to war.
D) excessive exports and imports that overload the global system.
E) monotonic expansion in global currency volume.
2) A balance of payments crises under fixed exchange rates occurs when
A) a country runs out of foreign reserves.
B) a country is in a liquidity trap.
C) exports and imports expand beyond some point.
D) marginal returns on foreign exchange investments approach zero.
E) forward currency markets undergo high volatility.