Econ 560, Winter 2011

Homework 2 – Part 1

A. Essay Questions

1. Why might detailed information on the state of the balance of payments be useful to
economists and to policymakers?

2. If interest rates differ between two countries, it is an indication that the financial markets
are not in equilibrium, and that investment flows should be taking place between the two
countries. Agree? Disagree? Explain.

3. (a) Draw a demand curve for foreign exchange (spot foreign exchange) by a home
country and briefly indicate why the curve has a downward slope. Then draw an upward-
sloping supply curve of foreign exchange to that country. (You do not need to explain
why it is upward-sloping.) Then indicate the equilibrium exchange rate in this spot
market and briefly explain why the market moves to this equilibrium position.

(b) Define the “forward market” for foreign exchange, draw a demand curve and supply
curve for the forward market, and indicate the equilibrium forward exchange rate.
Assume that the equilibrium forward exchange rate is identical to the equilibrium spot
exchange rate in part (a) of this question.

(c) Into this situation where the spot and exchange rates are equal, now suppose that, for
whatever reason, short-term interest rates suddenly rise in the home country while they do not
change in foreign countries. In the context of covered interest arbitrage, what forces are set in
motion and what will happen to the spot and forward exchange rates because of this change in
domestic interest rates? Carefully explain.

4. Explain the implication for a country’s exchange rate in the monetary approach and in the
portfolio balance approach of (a) an autonomous decline in the demand for money at each
interest rate by the country’s citizens, and (b) a change in expectations by the country’s citizens
such that less inflation is expected in the future.

5. If a country has a current account deficit, this is often referred to as a situation where the
country is “spending beyond its means.” What does this phrase mean in terms of the simple
Keynesian model? Does the existence of the current account deficit imply that the country as a
whole is a dissaver (i.e., that saving is actually negative)? Why or why not?

6. Suppose that autonomous consumption increases but that, unlike the situation in the
simple Keynesian model of this chapter, some of this autonomous consumption increase is spent
on imports (say an amount equal to MPM times the autonomous consumption increase) in the
“first round” of the multiplier process. What would this mean for the size of the open-economy
multiplier in comparison to the open-economy multiplier in the text?
7. Given the following Keynesian model:

Y=C+I+G+X-M I = 250
C = 80 + 0.75Yd G = 100
Yd = Y - T X = 200
T = 0.20Y M = 0.30Y

(a) Calculate the equilibrium level of income and indicate the value of the current
account balance when the economy is at its equilibrium income level.

(b) Suppose that all equations in the model above stay the same except the size of
exports. Calculate the level of exports needed to yield an equilibrium income level
that also has X = M, and indicate that resulting equilibrium income level.

8. Since under a fixed exchange rate system the exchange rate does not change, does this
mean that the BP curve never shifts? Why or why not? If it in fact does shift, what effects do
such movements have on the equilibrium interest rate and equilibrium income if financial capital
is imperfectly mobile? Briefly explain.

9. “Attempts to stimulate an economy with expansionary monetary policy will lead only to
a loss of some of the country’s international reserves and to no permanent change in income
under a fixed-rate system.” Agree? Disagree? Explain.

10. Fiscal policy is most effective in a fixed-rate system when capital is perfectly mobile
because there is no domestic “crowding out.” Explain what is meant by the term “crowding
out,” and then critically evaluate the previous statement using the IS/LM/BP model.

11. Under a flexible exchange rate system, changes in the foreign rate of interest will affect
both the financial markets and the real sector. Explain why this comes about using the
IS/LM/BP model. What influence, if any, does the degree of international capital mobility have
on the results?

12. If capital is imperfectly mobile (with BP flatter than LM), explain why governments find
fiscal policy less effective under flexible rates compared to fixed rates. Is fiscal policy ever
completely ineffective? If so, under what conditions? If not, why not?

13. Explain, using the IS/LM/BP model, how an increase in foreign interest rates can lead to
an increase in domestic interest rates.

14. Explain, in the IS/LM/BP framework with flexible exchange rates, the impact of an
autonomous increase in foreign demand for a country’s exports upon the country’s national
income, money supply, and exchange rate. If there is no impact on a variable, explain why.
B. Multiple choice questions: Identify the choice that best completes the statement or answers
the question

Chapter 20

1. If, because of Japan’s high saving rate (in excess of domestic investment spending),
Japan invests overseas, then this investment can cause __________ of the Japanese yen
and thus a consequent trade __________ for Japan.

a. a depreciation; deficit
b. a depreciation; surplus
c. an appreciation; deficit
d. an appreciation; surplus

2. If ef = the forward rate on three-months Swiss francs, e = the current spot rate on Swiss
francs, and E(e) = the expected future rate of the Swiss franc in three months, then the
Swiss franc is said to be at a forward discount if __________ is negative.

a. ef - e
e

b. e - ef
e

c. E(e) - e
e

d. E(e) - ef
ef

3. In a setting of flexible exchange rates, suppose that the U.S. citizens decrease their import
purchases from the United Kingdom at the same time that British citizens increase their
purchases of stocks and bonds in the United States. The first action (the U.S. imports) by
itself would lead to __________ of the dollar against the pound; the second action by
itself would __________ of the dollar against the pound.

a. an appreciation; lead to a depreciation

b. an appreciation; also lead to an appreciation
c. a depreciation; also lead to a depreciation
d. a depreciation; lead to an appreciation
4. Other things equal, if exchange rates are flexible, and if U.S. consumers increase their
demand for Japanese goods at the same time that Japanese consumers increase their
demand for U.S. goods, then we would expect the dollar to

a. appreciate relative to the yen.

b. depreciate relative to the yen.
c. remain unchanged in value relative to the yen.
d. appreciate, depreciate, or remain unchanged in value relative to the yen – impossible
to determine without more information.

5. Suppose that the equilibrium exchange rate is 120 Japanese yen = $1. If there is then a
change in preferences of U.S. consumers such that they now prefer more Japanese goods
in their consumption bundle, then, other things equal, the equilibrium exchange rate
__________, which is __________.

a. will move toward a lower price for the dollar (e.g., 115 yen = $1); an appreciation of
the yen relative to the dollar
b. will move toward a lower price for the dollar (e.g., 115 yen = $1); an appreciation of
the dollar relative to the yen
c. will move toward a higher price for the dollar (e.g., 125 yen = $1); an appreciation of
the yen relative to the dollar
d. will move toward a higher price for the dollar (e.g., 125 yen + $1); an appreciation of
the dollar relative to the yen

6. In which of the following relationships between the expected future spot rate [E(e)] of a
foreign currency and the current forward rate (efwd) of a foreign currency would a
speculator have an incentive to sell foreign currency in the forward market?

a. E(e) < efwd

b. E(e) > efwd
c. E(e) = efwd
d. E(e) = (1/efwd)

7. A simultaneous increase in U.S. demand for German products and decrease in the desire
of German investors to send funds to the United States would, with other things equal,
lead to __________ of the U.S. dollar against the euro and to __________ of the euro
against the dollar.

a. an appreciation; a depreciation
b. an appreciation; an appreciation
c. a depreciation; a depreciation
d. a depreciation; an appreciation
8. Given the following partially-completed table showing the quantity demanded of euros
and the quantity supplied of dollars in exchange for the euros:

exchange rate euros demanded dollars supplied

$2.00 = €1 €600 x
$1.50 = €1 y $1,500

The missing values are __________.

a. x = $1,200, y = €2,250
b. x = $1,200, y = €1,000
c. x = $300, y = €2,250
d. x = $300, y = €1,000

9. If a speculator observes that the current 3-months forward rate on Swiss francs is 20¢ = 1
franc, but he/she expects that the spot rate in 3 months will be 30¢ = 1 franc, then this
speculator would now

a. buy dollars on the forward market.

b. buy francs on the forward market.
c. sell francs on the forward market.
d. buy francs on the spot market and simultaneously sell francs on the 3-months forward
market if the current spot rate is 25¢ = 1 franc.

10. An exporter who is to receive payment in foreign currency in three months and who
wants to engage in “hedging” would __________ the foreign currency on the three-
months forward market in order to protect himself/herself from __________ of the
foreign currency.

a. buy; an appreciation
b. buy; a depreciation
c. sell; an appreciation
d. sell; a depreciation

11. Suppose that the three-months interest rate in New York is 4 percent and the three-
months interest rate in London is 3 percent, and that the spot rate is $2.00/£1 and the
three-months forward rate is $2.10/£1. In this situation, there is an incentive for short-
term interest arbitrage funds to flow

a. from New York to London.

b. from London to New York.
c. neither from New York to London nor from London to New York.
d. from New York to London, from London to New York, or in neither direction –
cannot be determined without more information.
12. Suppose that a speculator notes that the current three-months forward rate on the euro is
$1.36 and the speculator expects that, in three months, the euro will have a value of
$1.40. In this situation, the speculator would __________ euros on the forward market,
and this activity __________ for the speculator.

a. buy; involves risk

b. buy; involves no possible risk
c. sell; involves risk
d. sell; involves no possible risk

Chapter 22

13. 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
__________ and a consequent __________ of the country’s currency.

a. an incipient balance-of-payments surplus for the country; appreciation

b. an incipient balance-of-payments surplus for the country; depreciation
c. an incipient balance-of-payments deficit for the country; appreciation
d. an incipient balance-of-payments deficit for the country; depreciation

14. 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

a. xa = (id/if).
b. xa = id + if.
c. if = id + xa.
d. id = if + xa

15. 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
b. Ms = a(BR + C)
c. BR = Ms - C
d. aC = Ms - BR
16. 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.

a. an increase; an increase
b. an increase; a decrease
c. a decrease; an increase
d. a decrease; a decrease

17. 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

b. a increase in the home country price level
c. an increase in the home country real income level
d. a decrease in the expected rate of appreciation of the foreign currency (or a decrease
in the expected rate of depreciation of the home currency)

18. 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.
b. an increase in the supply of money (with a fixed demand) would cause a balance-
of-payments surplus under fixed exchange rates.
c. a decrease in the demand for money (with a fixed supply) would cause a balance-of-
payments deficit under fixed exchange rates.
d. an increase in the supply of money (with a fixed demand) would cause the domestic
currency to appreciate under flexible exchange rates.

19. Which one of the following, other things equal, would NOT cause an increase in the
amount of money demanded in country A?

a. an increase in A’s national income

b. an increase in the price level in country A
c. a fall in interest rates in country A
d. an increase in the rate of expected inflation in A
20. In the monetary approach to the balance of payments, 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.

a. incipient surplus; a depreciation

b. incipient surplus; an appreciation
c. incipient deficit; a depreciation
d. incipient deficit; an appreciation

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 __________.

a. decreases; also decreases

b. decreases; increases
c. increases; decreases
d. increases; also increases

22. 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.

a. decrease; a depreciation
b. decrease; an appreciation
c. increase; a depreciation
d. increase; an appreciation

23. 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,

a. E(e) = efwd.
b. e = efwd.
c. xa = efwd.
d. E(e) = e.
24. 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.

b. will reduce home country demand for foreign bonds.
c. will have an indeterminate effect on the domestic interest rate (without more
information).
d. will not affect the domestic demand for either foreign or domestic bonds.

25. 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.

a. excess supply of; a depreciation

b. excess supply of; an appreciation
c. excess demand for; a depreciation
d. excess demand for; an appreciation

26. 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?

a. an increase in the amount of money demanded at each income level in country B

b. an increase in the money supply in country B
c. a fall in real income in country B
d. a decrease in the money supply in country A

27. 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

b. a depreciation; also will lead to a depreciation
c. an appreciation; also will lead to an appreciation
d. an appreciation; will lead to a depreciation

Chapter 24

28. If a country has a current account deficit, this suggests that

a. the country’s spending is less than its income.

b. the country must also have a negative merchandise trade balance.
c. the country’s capital/financial account must also be in a deficit position.
d. the country’s saving is less than its investment.
29. If expansionary aggregate demand-oriented macroeconomic policy is to be used to move
the economy towards simultaneous external and internal balance, in which one of the
following situations would the policy indeed move the economy towards the attainment
of both goals?

a. deficit in the current account; unacceptably high unemployment

b. deficit in the current account; unacceptably rapid inflation
c. surplus in the current account; unacceptably high unemployment
d. surplus in the current account; unacceptably high inflation

30. Other things equal, in a Keynesian income model, the autonomous spending multiplier
will __________ if there is a decrease in the marginal propensity to consume, and the
autonomous spending multiplier __________ if there is a decrease in the marginal
propensity to import (MPM).

a. decrease; also will decrease

b. decrease; will increase
c. increase; will decrease
d. increase; also will increase

31. If the consumption function in a Keynesian model is C = 60 + 0.7Y, then the

associated saving function is __________.

a. S = - 60 + 0.3Y
b. S = - 60 + 0.7Y
c. S = 40 + 0.3Y
d. S = - 40 + 0.3Y

32. If the “multiplier” in a Keynesian open economy is 2.0, this is consistent with which
one of the following combinations of the marginal propensity to consume (MPC) and the
marginal propensity to import (MPM)? (Assume that there is no government sector.)

a. MPC = 0.7, MPM = 0.2

b. MPC = 0.3, MPM = 0.2
c. MPC = 0.8, MPM = 0.2
d. MPC = 0.5, MPM = 0.2

33. If national income is greater than spending by domestic residents, then the country will
have, in its balance of trade (or balance on current account)

a. a deficit.
b. a surplus.
c. neither a deficit nor a surplus.
d. either a deficit or a surplus – cannot be determined without more information.
34. In a Keynesian open-economy income model, an increase in autonomous investment in a
country is likely to lead to what impact (if any) on national income in a trading partner
country?

a. an increase
b. a decrease
c. no change
d. an increase, a decrease, or no change – cannot be determined without more
information

35. The income elasticity of demand for imports (YEM) is defined as

a. the change in imports divided by the change in income.

b. total imports divided by total income.
c. the change in income divided by the change in imports.
d. the percentage change in imports divided by the percentage change in income.

36. Suppose that, at the equilibrium level of income in a country, the country has a current
account (X-– M) deficit of 60. The country’s marginal propensity to consume = 0.7, and
the country’s marginal propensity to import = 0.2. If contraction in imports by means
of reducing national income is the method to be used to eliminate the current account
deficit, by how much must national income be reduced?

a. 30
b. 60
c. 120
d. 300

37. If an economy has a marginal propensity to import of 0.3 and the economy’s
balance-of-trade deficit is 15, how much must the economy contract its GNP if
income contraction is to be the method of removing the balance-of-trade deficit?

a. 4.5
b. 45
c. 50
d. 200

38. In a Keynesian model, if MPM = 0.2, MPC = 0.8, and there is no government sector,
what will be the ultimate effect of an autonomous increase in investment of 30 on the
imports of the country, other things equal?

a. increase by 6
b. increase by 15
c. increase by 75
d. decrease by 30
39. Suppose that a Keynesian import function is expressed as M = 20 + 0.25Y. With this
function,

a. if income = 1,000, imports = 250.

b. if income = 1,000, the average propensity to import is 0.27.
c. the marginal propensity to import is greater at an income level of 1,000 than at an
income level of 800.
d. the average propensity to import is greater at an income level of 1,000 than at an
income level of 800.

40. In a Keynesian income model, if a country’s actual level of income is above the
equilibrium income level, then there will be an __________ of inventories of firms and,
consequently, firms will __________ their level of output.

a. unintended depletion; increase

b. unintended depletion; decrease
c. unintended accumulation; increase
d. unintended accumulation; decrease

Chapter 25

41. In the ordinary analysis of IS and LM curves (ignoring the BP curve),

a. expansionary fiscal policy shifts the IS curve to the left.

b. expansionary monetary policy shifts the LM curve to the left.
c. expansionary fiscal and expansionary monetary policy undertaken at the same time
will lead to an increase in the level of equilibrium income.
d. expansionary fiscal policy and contractionary monetary policy acting together will
lead to a decline in the equilibrium interest rate.

42. In the Mundell prescription for monetary and fiscal policy under fixed exchange rates,
expansionary fiscal policy and contractionary monetary policy would be recommended if
a country were faced with

a. unemployment and a balance-of-payments deficit.

b. unemployment and a balance-of-payments surplus.
c. inflation and a balance-of-payments deficit.
d. inflation and a balance-of-payments surplus.
43. In a closed economy, an increase in the demand for money shifts the LM curve to the
__________; other things equal, this will lead to __________ in the level of national
income.

a. right; an increase
b. right; a decrease
c. left; an increase
d. left; a decrease

44. In the analysis of the use of expansionary or “easy” fiscal policy undertaken by a
country’s government in a situation of fixed exchange rates, the policy leads to
__________ of the country’s current account balance (or trade balance) and, if short-term
capital is highly mobile between countries, the policy __________ of the country’s
capital/financial account balance.

a. an improvement; also leads to an improvement)

b. an improvement; leads to a deterioration (or worsening)
c. a deterioration (or worsening); leads to an improvement
d. a deterioration (or worsening); also leads to a deterioration (or worsening)

45. Under fixed exchange rates and a constant price level, the automatic adjustment process
produces balance-of-payments equilibrium as

a. the LM curve shifts along the fixed IS and BP curves.

b. the IS curve shifts along the fixed LM and BP curves.
c. the IS, LM, and BP curves all shift.
d. the BP curve shifts to the point where the IS and LM curves intersect.

46. In the following diagram, with fixed exchange rates,

the economy is in domestic equilibrium at income level __________ and there is

__________.

a. Y1; a balance-of-payments surplus

b. Y2; a balance-of-payments deficit
c. Y2 ; a balance-of-payments surplus
d. Y3; equilibrium in the balance of payments
47. In the Mundell analysis in which, in a situation of fixed exchange rates, a country is using
monetary and fiscal policy to attain “external balance” (i.e., balance-of-payments
equilibrium) and “internal balance” (i.e., full employment without inflation), the country
__________. In this context, if the country has a balance-of-payments surplus at the
same time that it has inflation, the country should engage in __________.

a. should assign monetary policy to the attainment of internal balance and fiscal policy
to the attainment of external balance; expansionary (“easy”) monetary policy
and contractionary (“tight”) fiscal policy
b. should assign monetary policy to the attainment of internal balance and fiscal policy
to the attainment of external balance; contractionary (“tight”) monetary policy
and expansionary (“easy”) fiscal policy
c. should assign monetary policy to the attainment of external balance and fiscal policy
to the attainment of internal balance; expansionary (“easy”) monetary policy
and contractionary (“tight”) fiscal policy
d. should assign monetary policy to the attainment of external balance and fiscal policy
to the attainment of internal balance; contractionary (“tight”) monetary policy
and expansionary (“easy”) fiscal policy

48. Under fixed exchange rates,

a. fiscal policy is ineffective in influencing national income with all degrees of

international capital mobility.
b. fiscal policy is most effective in influencing national income when capital is perfectly
mobile internationally.
c. monetary policy is very effective in influencing national income if capital is perfectly
immobile internationally.
d. monetary policy is more effective when capital is perfectly mobile internationally than
when capital is perfectly immobile internationally.

49. In a system of fixed exchange rates, the automatic balance-of-payments adjustment

process for a country with a balance-of-payments deficit would theoretically involve,
among other things, __________ in the interest rate and __________ in national income.

a. a decrease; a decrease
b. a decrease; an increase
c. an increase; a decrease
d. an increase; an increase
50. In the diagram below, under fixed exchange rates, the automatic adjustment mechanism
will lead to

a. a fall in the money supply, a fall in income, and a fall in the interest rate.
b. a rise in the money supply, a fall in income, and a fall in the interest rate.
c. a fall in the money supply, a rise in income, and a rise in the interest rate.
d. a fall in the money supply, a fall in income, and a rise in the interest rate.

51. Under a fixed exchange rate, a balance-of-payments surplus for a country will lead to a
__________ in the money supply as the country’s central bank __________ in order to
maintain the fixed exchange rate.

a. rise; purchases domestic currency

b. rise; purchases foreign exchange
c. fall; sells domestic currency
d. fall; sells foreign exchange

52. A general rule is that, as international capital mobility for a country increases, the
country’s BP curve __________.

a. becomes steeper (less elastic)

b. maintains the same slope (or elasticity)
c. becomes flatter (more elastic)
d. eventually will become downward-sloping

53. In the IS-LM analysis (and ignoring the BP curve), if the economy is located at a point
that is to the left (or below) the IS curve and also to the left (or above) the LM curve,
there is __________ pressure in the real sector of the economy as well as an excess
__________ money.

a. expansionary; demand for

b. expansionary; supply of
c. contractionary; demand for
d. contractionary; supply of
54. Suppose, in the basic Mundell-Fleming diagram, that the economy is located at a point
that is above (or to the left) of the internal balance (IB) schedule and also above (or to the
left) of the external balance (EB) schedule. In this situation the economy is experiencing

a. unacceptably high unemployment and a balance-of-payments deficit.

b. unacceptably high unemployment and a balance-of-payments surplus.
c. unacceptably rapid inflation and a balance-of-payments deficit.
d. unacceptably rapid inflation and a balance-of-payments surplus.

55. Other things equal, if the if the demand for money becomes more elastic, then the LM
curve will become __________, i.e., a given rise in the interest rate will, in order for
money market equilibrium to be preserved, be associated with a __________ rise in
income.

a. less elastic; smaller

b. less elastic; larger
c. more elastic; smaller
d. more elastic; larger

56. Assume an initial equilibrium position for the economy (at the three-way intersection of
the IS, LM, and BP curves), and also assume that the BP curve is vertical. This situation
is one where there is __________ of financial capital internationally, and, from this initial
equilibrium, expansionary fiscal policy would initially lead to a balance-of-payments
__________.

a. perfect immobility; surplus

b. perfect immobility; deficit
c. perfect mobility; surplus
d. perfect mobility; deficit

57. From an initial equilibrium position for the economy (at the three-way intersection of the
IS, LM, and BP curves), and if the LM curve is steeper than the BP curve, expansionary
fiscal policy initially leads to a balance-of-payments (BOP) __________, and
expansionary monetary policy __________.

a. deficit; also initially leads to a BOP deficit

b. deficit; initially leads to a BOP surplus
c. surplus; initially leads to a BOP deficit
d. surplus; also initially leads to a BOP surplus
58. With imperfect capital mobility, the BP curve slopes upward because, starting from a
given balance-of-payments equilibrium position, a rise in national income will tend to
cause a __________, which must be counteracted by a rise in the interest rate in order to
cause a __________ that will restore BOP equilibrium.

a. BOP deficit; short-term financial capital inflow

b. BOP deficit; short-term financial capital outflow
c. BOP surplus; short-term financial capital inflow
d. BOP surplus; short-term financial capital outflow

Chapter 26

59. In a situation of flexible exchange rates, an exogenous increase in foreign interest rates
will cause __________ of the domestic currency and, most likely, a __________ in the
domestic interest rate.

a. a depreciation; a rise
b. an appreciation; a rise
c. a depreciation; a fall
d. an appreciation; a fall

60. In a situation of flexible exchange rates, other things equal, a shift of the IS curve to the
left will lead to __________ of the country’s currency if the BP curve is steeper than
the LM curve and __________ of the country’s currency if the LM curve is steeper than
the BP curve.

a. an appreciation; also will lead to an appreciation

b. an appreciation; will lead to a depreciation
c. a depreciation; will lead to an appreciation
d. a depreciation; also will lead to a depreciation

61. Suppose that country A with a flexible exchange rate undertakes expansionary monetary
policy. Especially if short-term funds are extremely mobile between countries, A’s
currency will tend to __________ because of this policy, and this result suggests that A’s
monetary policy will be __________ effective in influencing national income than if A
had a fixed exchange rate rather than a flexible exchange rate.

a. appreciate; less
b. appreciate; more
c. depreciate; less
d. depreciate; more
62. The IS/LM/BP analysis suggests that, if the BP curve is flatter than the LM curve and the
exchange rate is flexible, expansionary fiscal policy will lead to __________ of the
country’s currency, which will make the fiscal policy __________ effective in
influencing
national income than if the country had a fixed exchange rate.

a. a depreciation; more
b. a depreciation; less
c. an appreciation
d. an appreciation; less

63. Under a flexible-rate system, when the BP curve is flatter than the LM curve, an
autonomous increase in foreign interest rates will have what impacts on the domestic
interest rate and domestic national income?

a. domestic interest rate will increase, domestic national income will decrease
b. domestic interest rate will increase, domestic national income will not change
c. domestic interest rate will increase, domestic national income will increase
d. domestic interest rate will not change, domestic national income will decrease

64. If, other things equal, a country with a flexible exchange rate decreases its money supply,
this will lead to __________ in the value of the country’s currency, which will tend to
__________ the country’s national income.

a. a depreciation; increase
b. a depreciation; decrease
c. an appreciation; increase
d. an appreciation; decrease

65. If a country’s BP curve is upward-sloping (i.e., it is neither vertical nor horizontal), then
an intersection of the country’s IS and LM curves at a point above the BP curve will be
associated with __________ in the country’s balance of payments. With flexible
exchange rates, the country’s BP curve will consequently shift __________.

a. an incipient deficit; upward and to the left

b. an incipient deficit; downward and to the right
c. an incipient surplus; upward and to the left
d. an incipient surplus; downward and to the right

18
66. In the view of economists, which one of the following statements is true?

a. Fiscal policy is unambiguously more effective in influencing national income under

flexible exchange rates than under fixed exchange rates.
b. Fiscal policy is unambiguously more effective in influencing national income under
fixed exchange rates than under flexible exchange rates.
c. Monetary policy is unambiguously more effective in influencing national income
under flexible exchange rates than under fixed exchange rates.
d. Monetary policy is unambiguously more effective in influencing national income
under fixed exchange rates than under flexible exchange rates.

67. If we consider a situation of expansionary monetary policy under flexible exchange rates,
the monetary expansion will lead to __________ of the home currency and thus will be
__________ effective in increasing national income than under fixed exchange rates.

a. an appreciation; more
b. an appreciation; less
c. a depreciation; more
d. a depreciation; less

68. The effectiveness of monetary policy in influencing national income will, under a system
of fixed exchange rates, be __________ under a system of flexible exchange rates.

a. greater than
b. less than
c. perhaps greater than; perhaps less than
d. the same as

69. If, in the IS/LM/BP diagram in a situation where short-term capital is imperfectly mobile
internationally and a flexible exchange rate system exists, an incipient balance-of-
payments (official reserve transactions) surplus will cause the BP curve to shift
__________ and the IS curve to shift __________.

a. upward and to the left; downward and to the left

b. upward and to the left; upward and to the right
c. downward and to the right; downward and to the left
d. downward and to the right; upward and to the right

19
70. In the diagram below, under flexible exchange rates, this country has an incipient
balance-of-payments (official reserve transactions) __________; as a consequence, the
BP curve will shift __________.

a. surplus; upward and to the left

b. surplus; downward and to the right
c. deficit; upward and to the left
d. deficit; downward and to the right

20