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双语课程习题集

双语课程习题集
双语课程习题集

《国际金融学》(双语)课程习题集

目录

CHAPTER 12: NATIONAL INCOME ACCOUNTING AND THE BALANCE OF PAYMENTS . 3 CHAPTER 13: EXCHANGE RATES AND THE FOREIGN EXCHANGE MARKET: AN ASSET APPROACH (8)

CHAPTER 14: MONEY, INTEREST RATES, AND EXCHANGE RATES (16)

CHAPTER 15: PRICE LEVELS AND THE EXCHANGE RATE IN THE LONG RUN (20)

CHAPTER 16: OUTPUT AND THE EXCHANGE RATE IN THE SHORT RUN (26)

CHAPTER 17: FIXED EXCHANGE RATES AND FOREIGN EXCHANGE INTERVENTION (35)

CHAPTER 18: THE INTERNATIONAL MONETARY SYSTEM, 1870 – 1973 (43)

CHAPTER 19: MACROECONOMIC POLICY AND COORDINATION UNDER FLOATING EXC HANGE RATES (49)

CHAPTER 20: OPTIMUM CURRENCY AREAS AND THE EUROPEAN EXPERIENCE (54)

Chapter 12: National Income Accounting and the Balance of Payments

Multiple Choice Questions

1. A country’s gross national product (GNP) is

A. the value of all final goods and services produced by its factors of production and

sold on the market in a given time period.

B. the value of all intermediate goods and services produced by its factors of

production and sold on the market in a given time period.

C. the value of all final goods produced by its factors of production and sold on the

market in a given time period.

D. the value of all final goods and services produced by its factors of production and

sold on the market.

E. the value of all final goods and services produced by its factors of production,

excluding land, and sold on the market in a given time period.

Answer: A

2. GDP is supposed to measure

A. the volume of production within a country’s borders.

B. the volume of services generated within a country’s borders.

C. the volume of production of a country’s output.

D. GNP plus depreciation.

E. None of the above.

Answer: A

3. GNP equals GDP

A. minus net receipts of factor income from the rest of the world.

B. plus receipts of factor income from the rest of the world.

C. minus receipts of factor income from the rest of the world.

D. plus net receipts of factor income from the rest of the world.

E. None of the above.

Answer: D

4. In open economies,

A. saving and investment are necessarily equal.

B. as in a closed economy, saving and investment are not necessarily equal.

C. saving and investment are not necessarily equal as they are in a closed economy.

D. saving and investment are necessarily equal contrary to the case of a closed economy.

E. None of the above.

Answer: C

5. Which one of the following expressions is the most accurate?

A. CA = EX – IM.

B. CA = IM – EX.

C. CA=EX=IM.

D. CA = EX + IM.

E. None of the above.

Answer: A

6. A country’s current account

A. balance equals the change in its net foreign wealth.

B. balance equals the change in its foreign wealth.

C. surplus equals the change in its foreign wealth.

D. deficit equals the change in its foreign wealth.

E. None of the above.

Answer: A

7. The CA is equal to

A. Y – (C-I+G).

B. Y + (C+I+G).

C. Y – (C+I+G).

D. Y – (C+I-G).

E. Y – (C+I+G) = -CA, (i.e., minus the CA).

Answer: C

8. For open economies,

A. S = I.

B. S = I +CA.

C. S = I – CA.

D. S > I + CA.

E. S < I + CA.

Answer: B

9. An open economy

A. can save only by building up its capital stock.

B. can save only by acquiring foreign wealth.

C. cannot save either by building up its capital stock or by acquiring foreign wealth.

D. can save either by building up its capital stock or by acquiring foreign wealth.

E. None of the above.

Answer: D

10. In an open economy, private saving, S p , is equal to

A. I - CA + (G - T).

B. I + CA - (G - T).

C. I + CA + (G - T).

D. I - CA - (G - T).

E. I + CA + (G + T).

Answer: C

11. Every international transaction automatically enters the balance of payments

A. once either as a credit or as a debit.

B. twice, once as a credit and once as a debit.

C. once as a credit.

D. twice, both times as debit.

E. None of the above.

Answer: B

Essay Questions

1. Discuss the effects of government deficits on the current account.

Answer:

A hard and difficult issue.

During the Reagan administration, the creation of twin deficits, whereby slashing taxes, government deficits increased, which was accompanied with increased current account deficits. Using the identity CA = Private Saving - I - (G – T), one can see that if private

savings and I are constants, an increase in the deficit, namely an increase in (G – T), necessarily increases the CA deficits by the same magnitude.However, government

budget deficit may change both private savings and investment, thus avoiding a creation

of the twin deficits.

An example is the European countries reducing their budget deficits just prior to the introduction of the euro in January 1999. Now, under the “twin deficits: theory,” one

would have expected the EU’s current account surpluses to increase. This has never happened. The main reason was sharp reduction in private saving rates.

A good answer should discuss Ricardian equivalence, which argues that when the government cut taxes and raises its deficit, consumers anticipate that they will face

higher taxes later to pay for the resulting government debt. In anticipation, they raise

their own private saving to offset the fall in government saving. In addition, one should mention wealth effect in anticipation of one Europe, assets prices increased, lowering

private saving rates.

2. “The balance of payments is always balanced.” Discuss.

Answer: True. Every international transaction automatically enters the balance of payments twice,

once as a credit and once as a debit.

Current account + financial account + capital account = 0

3. “The balance of payments accounts seldom balance in practice.” Discuss.

Answer: True. The main reasons are due to the fact that data collected or received from different sources may differ in coverage, accuracy, and timing. In addition, data on services are

not

as reliable as data from the financial account. Moreover, accurate measurements of international interest and dividend receipts are particularly difficult.

Quantitative/Graphing Problems

1. Assume

C = 40 + 0.8(Y – T) G =10

I = 20

T = 0, where T are taxes.

A. Calculate Y at equilibrium.

Answer: Y = C + I + G

Y = 350

B. Calculate C, I, and G at equilibrium.

Answer: C = 40 + 0.8 Y = 320

I = 20

G = 10

C. Now assume,

EX = 5 + 4EP*/P

IM = 10 + 0.1 (Y – T) – 3EP*/P E =3

P* = 1.5

P = 2

Find equilibrium Y

Answer: Y = 269.1667

2. What can one learn from the following figure?

Answer:

The figure shows the U.S. current account and net foreign wealth from 1977 until 1996.

It shows that a string of current account deficits in the 1980s reduced America’s net foreign wealth until, by the end 1996, the country had accumulated a substantial net foreign debt. In 1987 the country became a net debtor to foreigners for the first time since World War I.

Chapter 13: Exchange Rates and the Foreign Exchange Market: An AssetApproach

Multiple Choice Questions

1. How many British pounds would it cost to buy a pair of American designer jeans

costing $45 if the exchange rate is 1.60 dollars per British pound?

A. 38.125 British pounds

B. 28.125 British pounds

C. 48.125 British pounds

D. 58.125 British pounds

E. 18.125 British pounds

Answer: B

2. What is the exchange rate between the dollar and the British pound if a pair of

American jeans costs 50 dollars in New York and 100 pounds in London?

A. 1.5 dollars per British pound

B. 0.5 dollars per British pound

C. 2.5 dollars per British pound

D. 3.5 dollars per British pound

E. 2 dollars per British pound

Answer: B

3. When a country’s currency depreciates,

A. foreigners find that its exports are more expensive, and domestic residents find

that imports from abroad are more expensive.

B. foreigners find that its exports are more expensive, and domestic residents find

that imports from abroad are cheaper.

C. foreigners find that its exports are cheaper; however, domestic residents are not

affected.

D. foreigners are not affected, but domestic residents find that imports from abroad

are more expensive.

E. None of the above.

Answer: E

4. An appreciation of a country’s currency

A. decreases the relative price of its exports and lowers the relative price of its

imports.

B. raises the relative price of its exports and raises the relative price of its imports.

C. lowers the relative price of its exports and raises the relative price of its imports.

D. raises the relative price of its exports and lowers the relative price of its imports.

E. None of the above.

Answer: D

5. Which one of the following statements is the most accurate?

A. A depreciation of a country’s currency makes its goods cheaper for for eigners.

B. A depreciation of a country’s currency makes its goods more expensive for

foreigners.

C. A depreciation of a country’s currency makes its goods cheaper for its own residents.

D. A depreciation of a country’s currency makes its goods cheaper.

E. None of the above.

Answer: A

6. A foreign exchange swap

A. is a spot sale of a currency.

B. is a forward repurchase of the currency.

C. is a spot sale of a currency combined with a forward repurchase of the currency.

D. is a spot sale of a currency combined with a forward sale of the currency.

E. None of the above.

Answer: C

7. An American put option on foreign exchange

A. gives the buyer the right to sell the foreign currency at a known exchange rate at any time during the period of the option.

B. gives the seller the right to sell the foreign currency at a known exchange rate at any time during the period of the option.

C. gives the buyer the right to sell the foreign currency at a known exchange rate at a specific time in the future.

D. obligates the buyer to sell the foreign currency at a known exchange rate at any time during the period of the option.

E. None of the above.

Answer: A

8. An American call option on foreign exchange

A. obligates you to buy foreign currency at a known price at any time during the period of the option.

B. gives you the right to buy foreign currency at a known price at any time

during the period of the option.

C. gives you the right to buy foreign currency at a known price at a specific day in the future.

D. gives you the right to sell foreign currency at a known price at any time during the period of the option.

E. None of the above.

Answer: B

9. Which one of the following statements is the most accurate?

A. The dollar rate of return on euro deposits is the euro interest rate plus the rate

of depreciation of the dollar against the euro.

B. The dollar rate of return on euro deposits is approximately the euro interest

rate minus the rate of depreciation of the dollar against the euro.

C. The dollar rate of return on euro deposits is the euro interest rate minus the

rate of depreciation of the dollar against the euro.

D. The dollar rate of return on euro deposits is approximately the euro interest

rate plus the rate of appreciation of the dollar against the euro.

E. The dollar rate of return on euro deposits is approximately the euro interest

rate plus the rate of depreciation of the dollar against the euro.

Answer: E

10. If the dollar interest rate is 10 percent and the euro interest rate is 6 percent, then

A. an investor should invest only in dollars.

B. an investor should invest only in euros.

C. an investor should be indifferent between dollars and euros.

D. it is impossible to tell given the information.

E. All of the above.

Answer: D

11. If the dollar interest rate is 10 percent, the euro interest rate is 6 percent, and the expected return on dollar depreciation against the euro is zero percent, then

A. an investor should invest only in dollars.

B. an investor should invest only in euros.

C. an investor should be indifferent between dollars and euros.

D. It is impossible to tell given the information.

E. All of the above.

Answer: A

12. If the dollar interest rate is 10 percent, the euro interest rate is 6 percent, and the expected return on dollar depreciation against the euro is 4 percent, then

A. an investor should invest only in dollars.

B. an investor should invest only in euros.

C. an investor should be indifferent between dollars and euros.

D. It is impossible to tell given the information.

E. All of the above.

Answer: C

13. If the dollar interest rate is 10 percent and the euro interest rate is 6 percent, and the expected return on dollar depreciation against the euro is 8 percent, then

A. an investor should invest only in dollars.

B. an investor should invest only in euros.

C. an investor should be indifferent between dollars and euros.

D. It is impossible to tell given the information.

E. All of the above.

Answer: B

14. If the dollar interest rate is 10 percent, the euro interest rate is 12 percent, and the expected return on dollar depreciation against the euro is negative 4 percent, then

A. an investor should invest only in dollars.

B. an investor should invest only in euros.

C. an investor should be indifferent between dollars and euros.

D. It is impossible to tell given the information.

E. All of the above.

Answer: A

15. Which of the following statements is the most accurate?

A. A rise in the interest rate offered by dollar deposits causes the dollar to

appreciate.

B. A rise in the interest rate offered by dollar deposits causes the dollar to

depreciate.

C. A rise in the interest rate offered by dollar deposits does not affect the U.S.

dollar.

D. For a given euro interest rate and constant expected exchange rate, a rise in the

interest rate offered by dollar deposits causes the dollar to appreciate.

E. None of the above.

Answer: D

16. Which of the following statements is the most accurate?

A. For a given U.S. interest rate and a given expectation with regard to the future

exchange rate, a rise in the interest rate paid by euro deposits causes the dollar to depreciate.

B. For a given U.S. interest rate and a given expectation with regard to the future

exchange rate, a rise in the interest rate paid by euro deposits causes the dollar

to appreciate.

C. A rise in the interest rate paid by euro deposits does not affect the value of the

dollar.

D. A rise in the interest rate paid by euro deposits causes the dollar to depreciate.

E. None of the above.

Answer: A

17. Suppose that the one-year forward price of euros in terms of dollars is equal to $1.113 per euro. Further, assume that the spot exchange rate is $1.05 per euro, and the interest rate on dollar deposits is 10 percent and on euros it is 4 percent. What is the rate of return on a covered euro deposit?

A. 0.10

B. 0.101

C. 0.102

D. 0.103

E. 0.104

Answer: D

18. Suppose that the one-year forward price of euros in terms of dollars is equal to $1.113 per euro. Further, assume that the spot exchange rate is $1.05 per euro, and the interest rate on dollar deposits is 10 percent and on euros it is 4 percent. Under these assumptions,

A. covered interest parity does hold.

B. covered interest parity does not hold.

C. It is hard to tell whether covered interest parity does or does not hold.

D. Not enough information is given to answer the question.

E. None of the above.

Answer: B

Essay Questions

1. What are the factors affecting the demand for foreign currency?

Answer: Three factors affect the demand for foreign currency. They are expected return, risk, and liquidity.

2. What is the interest parity condition?

Answer: The condition that the expected returns on deposits of any two currencies are equal when measured in the same currency is called the interest parity condition. It implies that potential holders of foreign currency deposits view them as equally desirable assets, i.e. risk is assumed away.

In notational forms: R $ = R E + (E e $/E – E $/E ) / E $/E.

3. Discusses the effects of a rise in the dollar interest rate on the exchanger rate.

Answer: For a given euro interest rate and constant expected exchange rate, a rise in the interest rate offered by dollar deposits causes the dollar to appreciate.

Quantitative/Graphing Problems

1. Compute how many dollars it would cost to buy an Edinburgh Woolen Mill sweater costing 50 British pounds for the following exchange rates:

2. For the following 15 cases, compare the dollar rates of return on dollar and euro

3. Calculate the interest rate in the United States, if interest parity condition holds, for the following 15 cases:

4. Assume that the euro interest rate is constant at 5 percent, and that the expected exchange rate is 1.05 dollars per one euro. Find the expected dollar return on euro

deposits for the following cases:

Chapter 14: Money, Interest Rates, and Exchange Rates Multiple Choice Questions

1. The aggregate money demand depends on

A. the interest rate.

B. the price level.

C. real national income.

D. All of the above.

E. Only A and C.

Answer: D

2. Which one of the following statements is the most accurate?

A. A decrease in the money supply lowers the interest rate, while an increase in

the money supply raises the interest rate, given the price level and output.

B. An increase in the money supply lowers the interest rate, while a fall in the money supply raises the interest rate, given the price level.

C. An increase in the money supply lowers the interest rate, while a fall in the money supply raises the interest rate, given the output level.

D. An increase in the money supply lowers the interest rate, while a fall in the money supply raises the interest rate, given the price level and output.

E. None of the above.

Answer: D

3. An increase in a country’s money supply

A. causes a more than proportional increase in its price level.

B. causes a less than proportional increase in its price level.

C. causes a proportional increase in its price level.

D. leaves its price level constant in long-run equilibrium.

E. None of the above.

Answer: C

4. Which one of the following statements is the most accurate?

A. A permanent increase in a country’s money supply causes a proportional long- run depreciation of its currency against foreign currencies.

B. A temporary increase in a country’s money supply causes a proportional long- run depreciation of its currency against foreign currencies.

C. A permanent increase in a country’s money supply causes a proportional long- run appreciation of its currency against foreign currencies.

D. A permanent increase in a country’s money supply causes a proportional

short-run depreciation of its currency against foreign currencies.

E. A permanent increase in a country’s money supply causes a proportional

short-run appreciation of its currency against foreign currencies.

Answer: A

5. After a permanent increase in the money supply,

A. the exchange rate overshoots in the short run.

B. the exchange rate overshoots in the long run.

C. the exchange rate smoothly depreciates in the short run.

D. the exchange rate smoothly appreciates in the short run.

E. None of the above.

Answer: A

Essay Questions

1. What are the main factors determining the aggregate money demand?

Answer: Three main factors: interest rate, the price level, and real national income. A rise in the interest rate causes each individual in the economy to reduce her demand for money. If the price level rises, individual households and firms will spend more money than before. When real national income (GNP) rises, the demand for money will rise.

2. Explain why one can write the demand for money as follows:

M d =P L (R, Y).

Answer: The aggregate money demand is proportional to the price level. Imagine that all prices in an economy doubled, but the interest rate and everyone’s real incomes remained unchanged. Then, the money value of eac h individual’s average daily transactions would then simply double, as would the amount of money each wishes to hold.

3. What will be the effects of an increase in real national income on the interest rate? Answer: An increase in real national income will increase the interest rate. If investment depends only on interest rate, this will cause investment to go down. The increases interest rate will cause an appreciation of the dollar.

4. Analyze the effects of an increase in the European money supply on the dollar/euro exchange rate.

Answer: The main points are: An increase in the European money supply will reduce the interest rate on the euro, and thus causes the euro to depreciates against the dollar. The U.S. money demand and money supply are not going to be affected, and thus the interest rate in the U.S. will remain the same.

5. Explain how the money markets of two countries are linked through the foreign exchange market.

Answer: The monetary policy actions by the Fed affect the U.S. interest rate, changing the dollar/euro exchange rate that clears the foreign exchange market. The European System of Central Banks (ESCB) can affect the exchange rate by changing the European money supply and interest rate.

重庆工商大学财政金融学院国际金融学双语课程习题集

6. “Although the price levels appear to display short-run stickiness in many countries, a change in the money supply creates immediate demand and cost pressures that eventually

lead to future increase in the price level.” Discuss.

Answer: (See pages 3479 – 380). The statement is true. The pressures come from three main sources: excess demand for output and labor; inflationary expectations; and raw material prices.

7. Explain the effects of a permanent increase in the U.S. money supply in the short run and

in the long run. Assume that the U.S. real national income is constant.

An increase in the nominal money supply raises the real money supply, lowering the interest rate in the short run. The money supply increase is considered to continue in the future; thus, it will affect the exchange rate expectations. This will make the expected return on the euro more

desirable and thus the dollar depreciates. In the case of a permanent increase in the

U.S. money supply, the dollar depreciates more than under a temporary increase in the

money supply.

Now, in the long run, prices will rise until the real money balances are the same as before the permanent increase in the money supply. Since the output level is given, the U.S. interest rate, which decreased before, will start to increase, until it will move back to its original

level. The equilibrium interest rate must be the same as its original long -run value. This increase in the interest rate must cause the dollar to appreciate against the euro after its sharp depreciation as a result of the permanent increase in the money supply. So a large depreciation is followed by an appreciation of the dollar. Eventually, the dollar depreciates

in proportion to the increase in the price level, which in turn increases by the same proportion as the permanent increase in the money supply. Thus, money is neutral, in the sense that it cannot

affect in the long run real variables, such as output, investment, etc.

8. Explain the following figure:

Answer:

The figure explains how the money markets of two countries are linked through the foreign exchange market. The monetary policy actions by the Fed affect the U.S. interest rate, changing the dollar/euro exchange rate that clears the foreign exchange market. The European System of Central Banks (ESCB) can affect the exchange rate by changing the European money supply and interest rate.

Chapter 15: Price Levels and the Exchange Rate in the Long Run Multiple Choice Questions

1. In order for the condition E$/HK$ = Pus/P HK to hold, what assumptions does the principle of purchasing power parity make?

A. No transportation costs and restrictions on trade; commodity baskets that are a reliable indication of price level.

B. Markets are perfectly competitive, i.e., P = M

C.

C. The factors of production are identical between countries.

D. No arbitrage exists.

E. All of the above.

Answer: E

2. Which of the following statements is the most accurate? The law of one price states:

A. In competitive markets free of transportation costs and official barriers to

trade, identical goods sold in different countries must sell for the same price

when their prices are expressed in terms of the same currency.

B. In competitive markets free of transportation costs and official barriers to trade, identical goods sold in the same country must sell for the same price

when their prices are expressed in terms of the same currency.

C. In competitive markets free of transportation costs and official barrier to trade, identical goods sold in different countries must sell for the same price.

D. Identical goods sold in different countries must sell for the same price when

their prices are expressed in terms of the same currency.

E. None of the above.

Answer: A

3. Under Purchasing Power Parity,

A. E $/E = P US / P E.

B. E $/E = P E / P ES.

C. E $/E = P US + P E.

D. E $/E = P US - P

E.

E. None of the above.

Answer: A

4. Which of the following statements is the most accurate? In general,

A. The monetary approach to the exchange rate is a long-run theory.

B. The monetary approach to the exchange rate is a short-run theory.

C. The monetary approach to the exchange rate is both a short- and long-run theory.

D. The monetary approach to the exchange rate neither long-run nor short-run theory.

E. None of the above statements is true.

Answer: A

5. The monetary approach makes the general prediction that

A. The exchange rate, which is the relative price of American and Europeanmoney, is fully determined in the long run by the relative supplies of thosemonies.

B. The exchange rate, which is the relative price of American and European money,

is fully determined in the short run by the relative supplies of thosemonies and the relative demands for them

C. The exchange rate, which is the relative price of American and Europeanmoney, is fully determined in the short- and long run by the relative supplies ofthose monies and the relative demands for them

D. The exchange rate, which is the relative price of American and European money,

is fully determined in the long run by the relative supplies of thosemonies and the relative demands for them

E. None of the above statements is true.

Answer: A

6. Under the monetary approach to the exchange rate theory, money supply growth at a constant rate

A. eventually results in ongoing price level deflation at the same rate, but

changes in this long-run deflation rate do not affect the full-employment

output level or the long-run relative prices of goods and services.

B. eventually results in ongoing price level inflation at the same rate, but changes in

this long-run inflation rate do affect the full-employment output level and

the long-run relative prices of goods and services.

C. eventually results in ongoing price level inflation at the same rate, but changes

in this long-run inflation rate do not affect the full-employment output level or the

long-run relative prices of goods and services.

D. eventually results in ongoing price level inflation at the same rate, but changes in

this long-run inflation rate do not affect the full-employment output level,

only the long-run relative prices of goods and services. E.

None of the above statements is true.

Answer: C

7. If people expect relative PPP to hold,

A. the difference between the interest rates offered by dollar and euro deposits

will equal the difference between the inflation rates expected, in the United

States and Europe, over the relevant horizon.

B. the difference between the interest rates offered by dollar and euro deposits will

equal the difference between the inflation rates expected in Europe and the

United States.

C. the difference between the interest rates offered by dollar and euro deposits

will equal the difference between the inflation rates expected, over the

relevant horizon, in the United States and Europe, in the short run.

D. the difference between the interest rates offered by dollar and euro deposits will

be above the difference between the inflation rates expected, over the

relevant horizon, in the United States and Europe. E.

None of the above statements is true.

Answer: A

8. Under PPP,

A. a rise in a country’s expected inflation rate will eventually cause a more-than

proportional rise in the interest rate that depositors of its currency offer in order to accommodate for the higher inflation.

B. a fall in a country’s expected inflation rate will eventually cause an equal rise

in the interest rate that depositors of its currency offer.

C. a rise in a country’s expected inflation rate will eventually cause an equal rise

in the interest rate that depositors of its currency offer.

D. a rise in a country’s expected inflation rate will eventually cause a less than

proportional rise in the interest rate that depositors of its currency offer to

accommodate the rise in expected inflation.

E. None of the above statements is true.

Answer: C

9. In the short run,

A. the interest rate can rise when the domestic money supply falls.

B. the interest rate can decrease when the domestic money supply falls.

C. the interest rate stays constant when the domestic money supply falls.

D. the interest rate rises in the same proportion as the domestic money supply falls.

E. None of the above statements is true.

Answer: A

10. Under sticky prices,

A. a fall in the money supply raises the interest rate to preserve money marketequilibrium.

B. a fall in the money supply reduces the interest rate to preserve money marketequilibrium.

C. a fall in the money supply keeps the interest rate intact to preserve moneymarket equilibrium.

D. a fall in the money supply does not affect the interest rate in the short run,only in the long run.

E. None of the above statements is true.

Answer: A

11. Which of the following statements is the most accurate?

A. Relative PPP is not a reasonable approximation to the data.

B. Relative PPP is sometimes a reasonable approximation to the data but usuallyperforms poorly.

C. Relative PPP is sometimes a reasonable approximation to the data.

D.PPP is sometimes a reasonable approximation to the data.

E. PPP is sometimes a reasonable approximation to the data but usually performspoorly. Answer: B

12. Which of the following statements is the most accurate?

A. PPP appears to be of limited use as a short-run explanation of exchange ratemovements.

B. PPP appears to be of limited use even as a short-run explanation of exchange ratemovements.

C. PPP appears to be of limited use even as a long-run explanation of exchange ratemovements.

D. Relative PPP appears to be of limited use even as a short-run explanation ofexchange rate movements.

E. None of the above statements is true.

Answer: C

13. The PPP theory fails in reality because

A. transport costs and restrictions on trade.

B. monopolistic or oligopolistic practices in goods markets.

C. the inflation data reported in different countries are based on different

commodity baskets.

D. A, B, and C.

E. A and B only.

Answer: D

Essay Questions

1. Explain Purchasing Power Parity.

Answer: PPP states that the exchange rate between two countries’ curre ncies equals the ratio of the countries’ price levels.

A fall in a currency’s domestic purchasing power (i.e. an increase in the domestic price

level) will be associated with a proportional currency depreciation in the foreign exchange market and vice versa.

E $/E = P US /P E where P is the price of a reference commodity basket.

Rearrange: P US = (E $/E ) x (P E )

Thus, PPP asserts that all countries’ price levels are equal when measured in terms of the

same currency.

2. Discuss the differences between Absolute PPP and Relative PPP.

Answer: Absolute PPP states that the exchange rate between two currencies equals the ratio of their price levels. Relative PPP states that the percentage change in the exchange rate between two currencies over a given period equals the difference between the inflation rates of those two currencies.

3. What are the predictions for the long run of the Monetary Approach?

Answer:

Money supplies: Given the equations,

E $/E = P US /P E

P US = M S US /L(R $ , Y US )

P E= M S E /L(R E , Y E )

one can show that an increase in the U.S. money supply, M S US, causes a proportional increase inthe U.S. price level, P US , which in turn causes a proportional increase in E $/€ . Thus, an increase inU.S. money supply causes a proportional long-run depreciation of the dollar against the euro andvice versa.

Interest rates: A rise in the interest rate R $ lowers U.S. money demand L(R $ , Y US ) thereby causing a rise in the U.S. price level and a proportional depreciation of the dollar against the euro.

Output levels: A rise in U.S. output Y US raises real U.S. money demand leading to a fall

in the long-run U.S. price level and an appreciation of the dollar against the euro.

4. What is the Fisher Effect? Provide an example.

Answer: All else equa l, a rise in a country’s expected inflation rate will eventually cause an

equal rise in the interest rate that deposits of its currency offer. Similarly, a fall in the expected inflation rate will eventually cause a fall in the interest rate.

5. What can explain the failure of relative PPP to hold in reality?

Answer: Government measures of the price level differ from country to country. One reason for these differences is that people living in different countries spend their income in different ways. Because of this inherent difference among countries, certain baskets will be affected more by price

changes given their consumptions basket. For example, consumers in country X eat more fish relative to consumers in another country. More than likely, the government, upon determining a commodity basket to reflect preference, will have an overwhelming representation of fish in their basket. Any price level change in the fish market will be felt particularly by country X, and their overall price level will reflect this. Thus, changes in the relative prices of basket components can cause relative PPP to become distorted.

Quantitative/Graphing Problems

1. Suppose Russia’s inflation rate is 200% over one year, but the inflation rate in Switzerland is only 2%. According to relative PPP, what should happen over the year to the Swiss franc’s exchange rate against the Russian ruble?

Answer: The exchange rate between the rubble and the franc at time (t – The same exchange rate at time t-1)/ the exchange rate between the rubble and the franc at time t = 2 – 0.02 =1.98.

So there will be a 198% depreciation of the ruble against the franc or, conversely, a

198% appreciation of the franc against the ruble.

Chapter 16: Output and the Exchange Rate in the Short Run

Multiple Choice Questions

1. The J-curve illustrates which of the following?

A. The effects of depreciation on the home country's economy

B. The immediate increase in the current account caused by a currencydepreciation

C. The gradual adjustment of home prices to a currency depreciation

D. The short-term effects of depreciation on the current account

E. The Keynesian view of international trade dynamics

Answer: D

2. The Marshall-Lerner Condition states that

A. depreciation always has a favorable effect on the current account.

B. import dependency reinforces the effects of depreciation on the currentaccount.

C. high elasticity of exports is sufficient for the favorable effects of depreciationon the current account to be observed.

D. depreciation has a favorable effect on the current account only if the sum ofexport and import elasticities is greater than one.

E. the sum of import and export elasticities must be equal to one in order fordepreciation to occur.

Answer: D

3. If the economy starts in long-run equilibrium, a permanent fiscal expansion will cause

A. an increase in exchange rate, E.

B. a decrease in exchange rate, E.

C. an increase in output, Y.

D. a decrease in output, Y.

E. shifting of the AA curve up and to the right.

Answer: B

4. In the long-run equilibrium, after a permanent money-supply increase there follows:

A. an increase in exchange rate, E.

B. a decrease in exchange rate, E.

C. an increase in output, Y.

D. a decrease in output, Y.

E. Both B and D.

Answer: A

5. Which of the following are true in terms of the current account balance?

A. Monetary expansion increases the current account balance.

B. Monetary expansion decreases the current account balance.

C. Fiscal expansion increases the current account balance.

D. Fiscal expansion decreases the current account balance.

E. Both A and D

Answer: E

6. In the short run, with prices fixed, how would an increase in government spending affect the DD-AA schedule?

A. It will increase output and appreciate the currency.

B. It will increase output and depreciate the currency.

C. It will decrease output and appreciate the currency.

D. It will decrease output and depreciate the currency.

E. None of the above.

Answer: A

7. How is the AA schedule derived?

A. The AA schedule has a positive slope because an increase in output leads to a depreciation of the currency.

B. The AA schedule has a negative slope because an increase in output leads to a decrease in the domestic interest rate.

C. The AA schedule has a negative slope because an increase in output leads to

an increase in the domestic interest rate.

D. The AA schedule has a positive slope because an increase in the money

supply leads to an increase in the domestic interest rate.

E. None of the above.

Answer: C

8. Imagine that the economy is at a point on the DD-AA schedule that is above both AA and DD, where both the output and asset markets are out of equilibrium. Which first action is true?

A. The economy will stay at this level in the short run.

B. The exchange rate will first drop to a point on the AA schedule.

C. The exchange rate will first move to a point on the DD schedule.

D. The AA-DD equilibrium will shift to the position of the economy.

E. None of the above.

Answer: B

9. Which one of the following statements is the most accurate?

A. An increase in disposable income improves the current account.

B. An increase in disposable income does not affect the current account.

C. An increase in disposable income worsens the current account.

D. An increase in income worsens the current account.

E. An increase in income improves the current account.

Answer: C

10. Which one of the following statements is the most accurate?

A. An increase in the real exchange rate and an increase in disposable income

improve the current account.

B. A decrease in the real exchange rate and a decrease in disposable income

improve the current account.

C. A decrease in the real exchange rate and a decrease in disposable income

improve the current account.

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