INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 22
1. The euro was introduced in January 1999 at $1.17 per euro. Its value dropped steadily
to around $0.82 per euro at its lowest. Fearing a currency crisis, the ECB (along with
the FED) decided to intervene in September 2000. Describe the concerted actions of
the ECB and of the FED. What was the impact on the euro and on the dollar?
2. At the end of the 1980s, the inflation rate in most ERM member countries had
converged towards the low and stable German inflation rate of 2 percent. In addition,
the real interest rate for all the member countries was equal to 3 percent. However the
Italian inflation rate was still a few points higher and the public expected it to remain 2
percentage points above the German rate.
a. What was the nominal interest rate in Italy? And in Germany?
b. As the exchange rate between the Deutsche Mark and the lira was permanently
locked and not expected to change to prepare the countries for EMU, in which
direction was capital flowing? Italy to Germany or Germany to Italy?
3. The existence of a European Economic and Monetary Union implies that the European
Central Bank must be completely in charge of the European monetary policy. The
monetary policy agreed upon by the ECB is now carried out by the various national
central banks. What important qualification had to be acquired by these national
central banks in order to become part of the European System of Central Banks?
Elaborate.
4. What is the fundamental difference between the “ECU” and the “euro” as European
monetary instruments?
5. Assume that a Mediterranean volcano blows up, damaging a large region of an EMU
member country. Explain what may or may not (but should) happen to stabilize the
economy of the region.
6. In order to finance the reunification of East and West Germany in the late eighties, the
German government issued new bonds to finance the reconstruction and
modernization of East Germany.
7. The lira and the Belgian franc are participating in the ERM with the +/– 2.25 percent
band, i.e. the currencies are allowed to fluctuate by this percentage around the central
parity (the official peg). Assume that the central parity between the Belgian franc and
the lira is 31.5 lira per Belgian franc and that, within a year, the market exchange rate
between the two currencies increases from 31.8 lira per Belgian franc to 32.3 lira per
Belgian franc (BF).
a. Which of the two currencies has appreciated?
b. Calculate whether this new exchange rate (32.3 Lira/BF) is still within the
acceptable band for these two ERM currencies.
c. If the currencies are out of the acceptable band, explain the mechanism of
compulsory intervention necessary to bring the two currencies back into the band.
Answer in terms of the action of each central bank, the Bank of Italy and the Bank of
Belgium.
d. Assuming that the movements in the exchange rates were due to different rates of
inflation, which country had the lower rate of inflation?
e. What is the impact of intervention on the real exchange rate of the country that has
the lower rate of inflation? (a real depreciation or a real appreciation?)
f. What is the effect on its international competitiveness?
8. The so-called “unholy trinity” problem. Explain with the use of graphs and references
to Chapter 18 why an exchange rate system, including pegged exchange rate, full
INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 22: Answers
1. The goal was to strengthen the euro or equivalently to weaken the dollar with respect
to the euro. Since it was a concerted intervention, both the European Central Bank and
3. In order to become a member of the European System of Central Banks, each
individual central bank had to become independent of its respective government. They
5. Let’s say that if Mount Etna erupts and destroys part of the productive capacity of
Sicily, fiscal transfer in the form of relief, aid, and development assets should flow from
7.
a. The Belgian Franc appreciates from 31.8 lira to 32.3 lira per BFr.
b. The bands within which the lira can fluctuate around the BFr are 31.5 ±2.25% or
between 30.79 and 32.21. The new exchange rate is out of the band.