CHAPTER 22
THE MONETARY AND PORTFOLIO BALANCE APPROACHES TO
EXTERNAL BALANCE
B. Multiple-Choice Questions
6. In the monetary approach to the balance of payments and the exchange rate, if there is an
excess demand for money, the result is a balance-of-payments __________ in a fixed
exchange rate situation and __________ of the country’s currency in a flexible exchange
rate situation.
7. If id is the domestic interest rate, if is the foreign interest rate, xa is the expected rate of
appreciation of the foreign currency (or the expected rate of depreciation of the home
currency), and financial capital is mobile across countries (and assuming no risk
premium), then equilibrium in international financial asset markets is indicated by the
expression
8. If Ms is the money supply, BR = reserves of commercial banks (depository institutions),
C = currency held by the nonbank public, and a = the money multiplier, then
a. Ms = aBR + C
9. Because of widespread risk aversion in the financial sector in recent years, commercial
banks in the United States have tended to hold __________ excess reserves than would
otherwise have been the case. A result of this bank behavior is that the “money
multiplier” in the U.S. economy is __________ than would otherwise have been the case.
10. Suppose that, for a country, its money supply (Ms) is at the moment equal to its demand
for money (Md). Now suppose that the country’s central bank pumps new money into the
economy. The result of this central bank action, other things equal, is that there will be
__________ under flexible exchange rates and a consequent __________ of the country’s
currency.
a. an incipient balance-of-payments surplus for the country; appreciation
11. In the monetary approach to the balance of payments and the exchange rate,
a. an increase in the demand for money (with a fixed supply) would cause a balance-of-
payments deficit under fixed exchange rates.
12. In the monetary approach to the balance of payments, under flexible exchange rates, an
increase in the proportion of income that people in country A wish to hold as money
would, other things equal, lead to an __________ in country A’s balance of payments and
therefore to __________ of A’s currency in the foreign exchange markets.
13. The term xa in the textbook is defined as the expected rate of appreciation of the foreign
currency. A mathematical way to express this definition [where e is the spot rate of the
foreign currency and E(e) is the expected future spot rate of the foreign currency] is
__________.
a. E(e) – e
14. Under a system of flexible exchange rates, the portfolio balance approach suggests that
an
increase in real income in a home country will lead to __________ of that country’s
currency; under flexible rates, the monetary approach suggests that an increase in real
income in a home country __________ of that country’s currency.
a. a depreciation; will lead to an appreciation
15. In the asset market or portfolio balance approach, other things equal, a depreciation of the
home currency would be caused by __________ in inflationary expectations in the home
country and by __________ in real income in the home country.
16. In the portfolio balance approach, which one of the following, other things equal, will
cause an increase in the demand for domestic bonds by home country citizens?
a. a decrease in the home country interest rate
17. In the portfolio balance model, other things equal, the issuance of new bonds by a home
corporation will __________ the domestic interest rate and, especially if home and
foreign bonds are very good substitutes for each other, will lead to __________ of the
home currency.
18. In the Dornbusch “overshooting” model, asset markets adjust __________ rapidly to
disturbances than do goods markets, and therefore the exchange rate and the price level
__________ proportionately to each other in the short run.
a. more; move
19. Which one of the following, other things equal, would NOT cause an increase in the
amount of money demanded in country A?
20. If e is the current spot rate (units of home currency per unit of foreign currency), efwd is
the current three-months forward rate, E(e) is the expected spot rate in three months, and
xa is the expected rate of depreciation of the home currency in three months, then, in an
efficient foreign exchange market,
21. In considering the demand for money in the monetary approach to the balance of
payments, it can be said that the money demand would increase if home real income
__________ and if the home interest rate __________.
22. In the monetary approach to the exchange rate, which one of the following will cause a
depreciation of A’s currency relative to B’s currency?
d. a decrease in the money supply in country A
23. In the portfolio balance model, other things equal, an increase in home country wealth
because of a current account surplus
a. will reduce home country demand for money.
24. In the monetary approach to the exchange rate, a decrease in income in country I
will, other things equal, lead to an __________ money in country I and therefore to
__________ of country I’s currency against other currencies.
d. excess demand for; an appreciation