Solutions to the End-of-Chapter Questions, Problems, and Data
Exercises
16.1 Foreign Exchange Intervention and the Monetary Base
Learning objective: Analyze how the Fed’s interventions in foreign exchange markets affect the
U.S. monetary base.
Review Questions
1.1 The difference is what the central bank is buying or selling. A foreign exchange market
1.3 The purchases have the same effect on the monetary base. In either case, the Fed acquires an
1.4 With a sterilized foreign-exchange intervention, the central bank offsets the effect of the
Problems and Applications
1.5 a. A sterilized intervention refers to a foreign exchange intervention where the central bank offsets
b. If the Fed purchased foreign assets, it would also sell U.S. Treasury securities, or if the Fed sold
c. A sterilized intervention will not have any effect on the value of the dollar because a sterilized
1.6 The Fed’s international reserves decrease by $5 billion, and the monetary base decreases by $5
Federal Reserve
Assets Liabilities
(international reserves)
1.7 The monetary base does not change. This is a sterilized intervention because the Fed took action
to offset the effect of the foreign exchange intervention on the monetary base.
Federal Reserve
Assets Liabilities
© 2014 Pearson Education, Inc.
Chapter 16 The International Financial System and Monetary Policy 206
1.8 a. The monetary base increases by $10 billion because bank reserves will increase by that amount.
16.2 Foreign Exchange Interventions and the Exchange Rate
Learning objective: Analyze how the Fed’s interventions in foreign exchange markets affect the
exchange rate.
Review Questions
2.3 Capital controls are government-imposed restrictions on foreign investors buying domestic
1. They can increase government corruption with government officials demanding bribes to
exchange domestic currency for foreign currency.
Problems and Applications
2.4 Foreign investors demand U.S. dollars. An increase in U.S. interest rates relative to Japanese
2.5 The sale of $5 billion of U.S. Treasury securities by the Bank of Japan will raise interest rates in
Japan by reducing the monetary base. The higher Japanese interest rates will increase the
© 2014 Pearson Education, Inc.
Chapter 16 The International Financial System and Monetary Policy 207
2.6 a. Raising the floor from 1.2 francs = €1 to 1.3 francs = €1 would result in a
b. To raise its floor exchange rate between the franc and the euro, the Swiss National
Bank would need to buy euro-denominated assets and sell Swiss francs, which would increase
© 2014 Pearson Education, Inc.
Chapter 16 The International Financial System and Monetary Policy 208
c. The SNB could add to its foreign-currency reserves indefinitely in the sense that it will not run
2.7 No. A foreign-exchange intervention by the Fed cannot change the exchange rate if the Fed
maintains its target for the federal funds rate because unless interest rates change, the demand
16.3 The Balance of Payments
Learning objective: Understand how the balance of payments is calculated.
Review Questions
3.1 The current account records transactions of currently produced goods and services, and the
3.2 Each international transaction represents an exchange of goods, services, or assets among
households, businesses, or governments. Therefore, the two sides of the exchange must always
3.3 When the official settlements balance is excluded from the financial account, a country can run a
Problems and Applications
3.6 The purchase of the 10 Volkswagen autos would be recorded in the current account as a
© 2014 Pearson Education, Inc.
Chapter 16 The International Financial System and Monetary Policy 209
3.8 When the official settlements balance is excluded from the financial account, a country can run a
balance-of-payments surplus (it gains international reserves) or a balance-of-payments deficit (it
3.9 If the financial account balance includes the official settlements balance, it would not be possible
16.4 Exchange Rate Regimes and the International Financial System
Learning objective: Discuss the evolution of exchange rate regimes.
Review Questions
4.1 The gold standard was a fixed exchange rate system under which currencies of participating
countries were convertible into an agreed-upon amount of gold. The quantity of gold held by a
country determined its money supply, and gold served as official reserves. Trade deficits lead to
4.2 a. The gold standard was a fixed exchange rate system with exchange rates determined by the
b. Countries were not able to pursue active monetary policies because the monetary base of a
c. Countries that ran trade deficits experienced gold outflows because they were importing more
e. During the Great Depression, some countries had to pursue contractionary monetary policies to
4.3 Devaluations and revaluations refer to the lowering (devaluation) and raising (revaluation) of a
country’s official fixed exchange rate. A depreciation refers to a drop in the value of a currency
Devaluations also increased the domestic currency price of imports, potentially increasing the
© 2014 Pearson Education, Inc.
Chapter 16 The International Financial System and Monetary Policy 210
4.4 The euro zone refers to the 17 European countries that use the euro as a common currency.
Using a single currency eliminates the transactions costs of currency conversion and eliminates
4.5 Pegging is the decision by a country to keep the exchange rate fixed between its currency and
another country’s currency. Countries peg their currencies to gain the following advantages of a
Problems and Applications
4.6 Under a gold standard, inflation is possible from: 1) a trade surplus that leads to a gold inflow,
4.7 Leaving the gold standard in the 1930s led to an increase in a country’s output and employment
for two reasons. First, the country’s central bank would be free to pursue an expansionary
4.8 The United States left the gold standard in 1933 when the federal government announced that it
was no longer willing to exchange domestic currency for gold. When the United States joined
4.9 The support for a fixed exchange system has tended to be higher in Europe than in the United
4.10 a. The euro eliminates the transactions costs of currency conversion.
b. A competitive devaluation occurs when a country on a fixed-exchange rate reduces the foreign
c. If countries abandon the euro and return to using their own currencies, then the single European
market is destroyed in the sense that the countries do not benefit from the reduction in
© 2014 Pearson Education, Inc.
Chapter 16 The International Financial System and Monetary Policy 211
4.11 a. “A Greek departure from the euro monetary union” means that Greece would drop out of the
b. A Greek departure from the euro would likely lead to severe financial consequences for Greece
as bank deposits in euros would be converted to drachmas. If euros are exchanged for drachmas
4.12 a. To the degree that the Chinese yuan is undervalued, the prices of U.S. exports to China are
b. The undervaluation of the yuan makes exports of U.S. goods and services to China more
4.13 a. China pegged the yuan to the U.S. dollar from 1994 to mid-2005 and to a basket of currencies
b. The volatility of the yuan poses exchange-rate risks for businesses and investors because
Data Exercises
D16.1
© 2014 Pearson Education, Inc.
Chapter 16 The International Financial System and Monetary Policy 212
D16.2
© 2014 Pearson Education, Inc.