QUESTIONS
9-1. What benefits does using a single currency, the euro, provide to European
countries?
(LO 9.1; AACSB: Application of knowledge)
■ A common currency, such as the euro:
◘ Integrates the EU economies into a unified whole
9-2. What challenges does the European Central Bank face in developing
monetary policy for the EU?
(LO 9.5; AACSB: Analytical Thinking)
■ Complexity-
■ The ECB treats the euro zone as one market, rather than as separate countries with
different economies.
– CHALLENGING
◘ ECB policy- Control inflation by limiting the money supply vs. control deflation
by increasing the money supply
◘ Fixing deflation in one country might trigger inflation in another.
■ Complicated- ECB monetary policy- the recent admission into the EU of
lower-income Eastern European countries, such as Slovakia and Slovenia
■ Diverse economic conditions
■ ECB officials worried about weakening the euro zone’s strained banking
system.
9-3. What is the effect of a weak euro on European exporters? What is the effect
on European consumers?
(LO 9.2; AACSB: Analytical Thinking)
■ Initial goal of a unified economy/currency was to shield EMU countries from currency
volatilities.
■ Following its launch, the euro was relatively weak against the USD
■ When the euro strengthened, it became problematic for European exporters because
it made their products relatively expensive to foreign importers, such as U.S., who buy
European goods using dollars.
● SUGGESTED SOLUTIONS TO CASE QUESTIONS
9-4. Explain the advantages and disadvantages of the globalization of finance.
How did it contribute to the global financial crisis?
(LO 9.5; LO 9.6; AACSB: Analytical Thinking)
■ Capital flows are volatile, thus when contagion occurs, financial instability is worsened
when governments failed to adequately regulate and monitor their banking and financial
sectors.
Global Financial System
■ Globalization of finance means global interconnectedness.
■ The global financial system consists of the collective financial institutions that facilitate
and regulate flows of investment and capital funds worldwide.
■ Key players – finance ministries, national stock exchanges, commercial banks,
■ The system incorporates the national and international banking systems, the
■ 1960s- (since) – grown in volume and structure, becoming more efficient, competitive,
and stable
■ 1960s- FDI-related funds
■ Advantages of financial flows- developing economies- increases their foreign
■ The growing integration of financial and monetary global activity is driven by:
■ Disadvantages- Financial risks linked to the globalization of financial flows:
◘ Capital flows are much more volatile than FDI-type investments. It is much
How did the globalization of finance contribute to the global financial crisis?
■ AIG was at the forefront of the globalization of finance.
■ AIG’s failure pulled down its network of investors such as mutual funds, pension funds,
■ Contagion: AIG’s demise meant crisis for its foreign investors.
■ Some $58 billion of the U.S. government bailout went to foreign banks in France and
Germany and to investors in the United Kingdom, Switzerland, and the Netherlands.
■ U.S. institutions received roughly $44 billion.
■ Many Americans resented how their tax dollars were used on a massive scale to
9-5. Describe how the fall of AIG exemplifies contagion. How did the U.S.
government bailout of AIG benefit foreign as well as U.S. firms and investors?
Experts are advocating increased regulation to prevent contagion. At the national
and international levels, what types of regulation might prevent future crises?
(LO 9.5; AACSB: Analytical Thinking)
■ AIG’s insured and investors included international banks including Société Générale
and BNP Paribas of France, Deutsche Bank of Germany, and Barclay’s of England.
■ If AIG failed, many of these would fail too. This is contagion: because of the
Examples-
■ Sorting the Lehman Brothers Treasury subsidiary bankruptcy in Amsterdam is a
■ Central and Eastern Europe (CEE) suffer from devalued local currencies and
mounting foreign currency debt. Currencies in the Czech Republic, Hungary, and
■ The U.S. has a trade deficit with China that reached $266 billion in 2008. However,
Experts are advocating increased regulation to prevent contagion. At the national
and international levels, what types of regulation might prevent future crises?
■ This question should generate some interesting research and debate.
■ Students may think the World Bank or the IMF should manage and regulate the global
■ Students may suggest that national central banks should regulate financial activity,
■ Nevertheless, governments are sure to clamp down on financial institutions –domestic
9-6. Several European countries have adopted a single currency, the euro.
Describe how adopting the euro might benefit countries in Eastern Europe. What
are the advantages and disadvantages of a single currency regime in
international financial transactions?
(LO 9.1; LO 9.4; AACSB: Analytical Thinking)
■ 1993- The European Union (EU) was established.
■ Goal- Common currency- the euro- thus the EU created the European Monetary Union
Note that Denmark, Sweden and the United Kingdom are still not participating in
the monetary union.
Advantages
■ A common currency, such as the euro:
◘ Integrates the EU economies into a unified whole
Disadvantages
■ Complexity- ECB monetary policy- each euro zone country is characterizes by
diverse economic and fiscal conditions
■ Complicated- ECB monetary policy- the recent admission into the EU of poorer
■ Asymmetric economic conditions
■ ECB officials worried the global economic crisis would weaken the euro zone’s
strained banking system.
■ The global economic crisis renewed discussion about the risks of EU monetary
integration.
■ Initial goal of a unified economy/currency was to mitigate currency volatilities
■ Following the euro launch, it was relatively weak relative to the USD
■ The success of the euro as a unifying force in Europe has changed the
international balance of power
■ U.S. global policy initiatives have been challenged by European governments
■ The central banks of numerous countries—including Canada, China, and Russia—are
9-7. As the world emerges from the global financial crisis, what is the potential
role of each of the following: firms, banks, central banks, national governments,
the International Monetary Fund, and the World Bank? What is the role of
national governments in stimulating national economic growth?
(LO 9.5; LO 9.6; AACSB: Analytical Thinking)
■ The crisis highlights the importance of strong regulation, transparency, and
supervision of institutions in the global financial system.
■ Firms, banks, central banks, national governments, the International Monetary Fund,
http://www.imf.org/external/pubs/cat/longres.cfm?sk=22975.0
Accessed October 9, 2015
■ In a report by Jonathan E. Sanford, Specialist in International Trade and Finance
and Martin A. Weiss, Specialist in International Trade and Finance, titled: The Global
Financial Crisis: Increasing IMF Resources and the Role of Congress, published by
the Congressional Research Service, on June 5, 2009. Excerpt below:
■ The global financial crisis has tested the IMF and other international financial
institutions (IFIs) in providing sufficient assistance to affected countries. It has also
enhanced the IMF’s role in crisis management and given it a key place in current efforts
to reform the world financial system.
■ The IMF’s financial resources have been expanded by the G-20 as follows:
◘ New Arrangements to Borrow (NAB), a supplemental fund to bolster IMF
resources, should be increased by up to $500 billion from its present level of $50 billion.
http://www.dtic.mil/cgi-bin/GetTRDoc?AD=ADA501414
Accessed October 9, 2015
From a different lens, look at an article written by Charles W. Calomiris, at the time was
the Paul M. Montrone Professor of Finance and Economics at Columbia Business
School and Director of the American Enterprise Institute Project on Financial
Deregulation, for the Cato Journal (Vol. 17, No. 3), a free market publication. Titled
THE IMF’S IMPRUDENT ROLE AS LENDER OF LAST RESORT and poignantly
http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/1998/1/cj17n3-5.pdf
Accessed October 9, 2015,
Some analysts predict that banks will consolidate even more as a result of the
global financial crisis of 2008. Do you think such a move would protect
economies from future crisis, or make them more vulnerable?
■ Using classic monopolistic theory, consolidation of banking worldwide would tend to
create greater concentration which is not likely to benefit consumers.
■ Further, more concentration increases the complexity of financial institutions making it
hard to deconstruct the activities of any one organization.
■ On the contrary, students might recommend that instead of consolidation, regulation
be passed to require that depository banks not be allowed to do business in other types
of financial services considered beyond the risk tolerance of their core business.
What is the role of national governments in stimulating national economic
growth?
■ To be successful, national governments through monetary and fiscal policies must
create a system that inspires confidence and ensures liquidity in monetary and financial
holdings.
■ The central bank is the monetary authority that regulates the money supply and
controls the monetary policy.
■ It implements monetary policy by increasing or decreasing the money supply through
one of the following methods:
■ The central bank may also function as the lender of last resort in the event of a
financial crisis.
■ Example- the Federal Reserve Bank of the United States (the Fed) formulates and
conducts U.S. monetary policy by influencing the money supply and credit conditions in
the U.S. economy. The Fed’s main goal is to keep inflation low.
■ In a free market, the “price” of any currency (rate of exchange) is determined by
supply and demand.
■ Monetary intervention (conducted by the Central Bank) – involves buying and selling
government securities to maintain a certain currency exchange rate.
◘ If the Fed wanted to support the value of the U.S. dollar, it might buy dollars in
the foreign exchange market.
As the world emerges from the global financial crisis, what is the potential role of
each of the following: firms, banks, central banks, national governments, the
International Monetary Fund, and the World Bank? What is the role of national
governments in stimulating national economic growth?
Assign students to groups representing one of the following perspectives:
Most Government
Regulation
Mixed Government
Regulation
Least Government
Regulation
Each group should present their arguments for the perspective that they are
representing to the class. This should stimulate much class discussion.
V. END OF CHAPTER QUESTIONS
● TEST YOUR COMPREHENSION
9-8. Distinguish between exchange rate and foreign exchange. What does each
term mean?
(LO 9.1; AACSB: Application of knowledge)
■ An exchange rate is the price of one currency expressed in terms of another.
■ Foreign exchange refers to all forms of money that are traded internationally,
including foreign currencies, bank deposits, checks, and electronic transfers.
9-9. Distinguish between convertible and nonconvertible currencies.
(LO 9.1; AACSB: Application of knowledge)
■ Convertible currency- can be readily exchanged for other currencies.
■ Hard currencies- most convertible currencies- universally accepted, such as the U.S.
9-10. Exchange rates fluctuate constantly. What is the effect of this fluctuation
on firms engaged in international business?
Visit MyManagementLab for suggested answers.
(LO 9.2; AACSB: Analytical Thinking)
9-11. What was the Bretton Woods agreement and what is its legacy today?
(LO 9.3; AACSB: Application of knowledge)
■ 1944- evolution of the modern exchange rate system began with the Bretton Woods
agreement, which aimed to stabilize exchange rates worldwide.
■ 1971- the system collapsed as currency values were allowed to float according to
market forces.
Detailed explanation:
Bretton Woods Legacy: Principles and Institutions Currently in Use
[1] -Bretton Woods instituted the concept of international monetary cooperation,
especially among the central banks of leading nations.
[2]-Bretton Woods established the importance of currency convertibility, in which all
countries adhere to restrictions on currency trading to avoid discriminatory currency
arrangements. This principle is an integral component of global free trade that the
world is experiencing today.
[3] -It established the idea of fixing exchange rates within an international regime so as
to minimize currency risk.
IMF and the World Bank
[4] – It created the International Monetary Fund [IMF] (www.imf.org) and the World
Bank (www.worldbank.org).
■ IMF is an international agency that aims to stabilize currencies by monitoring the