# Econ 3229 Ch 19

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• 1.

### 1. If capital flows freely between countries and a country has a fixed exchange rate, one thing you know is that the country:

• A.

Exports more than it imports

• B.

Must have ample gold reserves

• C.

Cannot have a domestic monetary policy

• D.

Must be running large trade deficits

C. Cannot have a domestic monetary policy
Explanation
If capital flows freely between countries and a country has a fixed exchange rate, it means that the country cannot have a domestic monetary policy. This is because a fixed exchange rate requires the country to maintain the value of its currency relative to other currencies. To do this, the country must give up its ability to independently control its monetary policy, such as setting interest rates or printing money. Instead, the country must adjust its monetary policy to match the policies of the country or countries to which its currency is fixed.

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• 2.

### 2. If the inflation rate in country A is 3.5% and the inflation rate in country B is 3.0%, we should expect the percentage change in the number of units of country A's currency per unit of country B's currency to be:

• A.

+0.5%

• B.

-0.5%

• C.

+ 16.7%

• D.

+6.5%

B. -0.5%
Explanation
We should expect the percentage change in the number of units of country A's currency per unit of country B's currency to be -0.5%. This is because if the inflation rate in country A is higher than in country B, it means that the value of country A's currency is depreciating faster compared to country B's currency. As a result, the number of units of country A's currency needed to exchange for a unit of country B's currency will decrease, leading to a negative percentage change of -0.5%.

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• 3.

### 3. If country A wants to fix its exchange rate with country B, then:

• A.

Country A's inflation rate will have to match country B's

• B.

Country A's monetary policy must be conducted so the inflation rate in country A matches the inflation rate in country B

• C.

Country A's monetary policy will not be able to be used to address domestic issues

• D.

All of the answers given are correct

D. All of the answers given are correct
Explanation
The correct answer is that all of the answers given are correct. This means that if country A wants to fix its exchange rate with country B, its inflation rate will have to match country B's. Additionally, country A's monetary policy must be conducted in a way that ensures the inflation rate in country A matches the inflation rate in country B. Finally, country A's monetary policy will not be able to be used to address domestic issues.

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• 4.

### 4. International capital mobility:

• A.

Contributes to the rigidity of exchange rates

• B.

Contributes to the equalization of expected returns across countries

• C.

Eliminates arbitrage opportunities

• D.

Makes interest rates equal across countries

B. Contributes to the equalization of expected returns across countries
Explanation
International capital mobility refers to the ability of capital to move freely between countries. This allows investors to seek out higher returns on their investments, regardless of where they are located. As a result, capital flows can help equalize expected returns across countries. When there is a higher return on investment in one country, capital will flow into that country, increasing the demand for its currency and causing its exchange rate to appreciate. Conversely, when there is a lower return on investment in a country, capital will flow out, decreasing the demand for its currency and causing its exchange rate to depreciate. Therefore, international capital mobility contributes to the equalization of expected returns across countries.

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• 5.

### 5. If the bonds of two different countries are identical, their expected returns will:

• A.

Be equal if capital flows freely internationally

• B.

Always be equal

• C.

Be equal only if the exchange rate between the two countries is fixed

• D.

Be equal only if the inflation rate is the same in each country

A. Be equal if capital flows freely internationally
Explanation
If the bonds of two different countries are identical, their expected returns will be equal if capital flows freely internationally. This is because when capital flows freely, investors can easily move their money between countries to take advantage of higher returns. As a result, the demand for bonds in both countries will be equalized, leading to equal expected returns. However, if capital flows are restricted or there are barriers to international investment, the expected returns may not be equal as investors may not be able to freely access the higher returns available in the other country.

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• 6.

### 6. When arbitrage occurs across countries with flexible exchange rates and when the bonds in each country are identical and there are no barriers to capital flows:

• A.

The interest rates on the bonds will be identical

• B.

The prices of the bonds will be identical

• C.

The inflation rates in each country will be identical

• D.

None of the answers provided is correct

D. None of the answers provided is correct
Explanation
In a situation where arbitrage occurs across countries with flexible exchange rates and when the bonds in each country are identical with no barriers to capital flows, the interest rates on the bonds will not necessarily be identical. This is because interest rates are influenced by various factors such as inflation, economic conditions, and monetary policies of each country. Similarly, the prices of the bonds will not necessarily be identical as they are determined by supply and demand factors in each country's bond market. Additionally, the inflation rates in each country will not necessarily be identical as inflation is influenced by various domestic factors. Hence, none of the answers provided is correct.

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• 7.

### 7. Which of the following statements is incorrect?

• A.

A country cannot be open to international capital flows, control its domestic interest rate and fix its exchange rate

• B.

A country can be open to international capital flows and control its own domestic interest rate but it can't fix its exchange rate

• C.

A country can be open to international capital flows, control its domestic interest rate, and fix its exchange rate

• D.

A country cannot be open to international capital flows if it expects to control its own domestic interest rate and to fix its exchange rate

C. A country can be open to international capital flows, control its domestic interest rate, and fix its exchange rate
Explanation
This statement is incorrect because a country cannot be open to international capital flows, control its domestic interest rate, and fix its exchange rate simultaneously. When a country allows international capital flows, it gives up some control over its domestic interest rate and exchange rate. If it wants to fix its exchange rate, it needs to restrict capital flows and give up control over its interest rate. Therefore, the correct answer is that a country cannot be open to international capital flows, control its domestic interest rate, and fix its exchange rate at the same time.

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• 8.

### 8. The United States would be characterized as having:

• A.

A controlled domestic interest rate, a closed capital market and a flexible exchange rate

• B.

A controlled domestic interest rate, an open capital market and a flexible exchange rate

• C.

No control over the domestic interest rate, an open capital market and a flexible exchange rate

• D.

A controlled domestic interest rate, an open capital market and a fixed exchange rate

B. A controlled domestic interest rate, an open capital market and a flexible exchange rate
Explanation
The United States would be characterized as having a controlled domestic interest rate because the Federal Reserve has the authority to set and adjust interest rates to control inflation and stimulate economic growth. It also has an open capital market, meaning that foreign investors can freely invest in US financial markets. Lastly, the US has a flexible exchange rate, which means that the value of the US dollar fluctuates based on market forces such as supply and demand.

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• 9.

### 9. Which of the following would be an example of a capital outflow control?

• A.

Mexico limiting the number of U.S. dollars an American can bring into the country

• B.

Mexico limiting the number of U.S. dollars its citizens can purchase before leaving on their vacation to the U.S.

• C.

Mexico limiting the number of pesos its citizens can take out of the country

• D.

All of the answers given would be examples of capital outflow controls

C. Mexico limiting the number of pesos its citizens can take out of the country
Explanation
This answer is correct because it describes a situation where Mexico is implementing a control on the outflow of its own currency, pesos, by limiting the amount its citizens can take out of the country. This is an example of a capital outflow control because it restricts the movement of capital from Mexico to other countries. The other options do not involve controlling the outflow of capital, but rather the inflow or purchase of foreign currency.

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• 10.

### 10. If foreigners are restricted in their ability to buy investments in a country then that government is imposing:

• A.

Controls on capital inflows

• B.

Controls on capital outflows

• C.

Controls on both capital inflows and outflows

• D.

Fixed exchange rates

A. Controls on capital inflows
Explanation
If foreigners are restricted in their ability to buy investments in a country, it means that the government is imposing controls on capital inflows. This means that the government is regulating and limiting the amount of foreign investment that can enter the country.

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• 11.

### 11. If the Fed desired to fix the euro/dollar exchange rate, they would have to:

• A.

Get the European Central Bank to also agree to fixed exchange rates

• B.

Maintain ample reserves of dollars

• C.

Be willing to exchange dollars for euros whenever anyone asked

• D.

Impose capital controls

C. Be willing to exchange dollars for euros whenever anyone asked
Explanation
If the Fed desired to fix the euro/dollar exchange rate, they would have to be willing to exchange dollars for euros whenever anyone asked. This means that the Fed would need to have a sufficient amount of euros in reserve and be ready to exchange them for dollars at the fixed rate whenever there is a demand for it. This would help maintain the fixed exchange rate between the two currencies.

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• 12.

### 12. If the Fed decides to maintain a fixed euro/dollar exchange rate when they purchase euros:

• A.

They increase the number of dollars

• B.

Downward pressure is put on domestic interest rates

• C.

The domestic money supply increases

• D.

All of the answers given are correct

D. All of the answers given are correct
Explanation
When the Fed decides to maintain a fixed euro/dollar exchange rate and purchases euros, they increase the number of dollars in circulation. This increase in the money supply puts downward pressure on domestic interest rates. Therefore, all of the answers given are correct.

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• 13.

### 13. Reserves in the banking system will increase if the Fed:

• A.

• B.

• C.

Buys both euros and dollars at the same time

• D.

Sells both euros and dollars at the same time

A. Buys euros or sells dollars
Explanation
When the Fed buys euros or sells dollars, it essentially increases the supply of dollars in the banking system. This leads to an increase in reserves in the banking system because banks receive more dollars from the Fed. Therefore, the correct answer is "Buys euros or sells dollars."

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• 14.

### 14. The impact on the foreign exchange market for dollars resulting from the Fed purchasing euros will be:

• A.

A decrease in the demand for dollars

• B.

An increase in the demand for dollars

• C.

An increase in the supply of euros

• D.

An increase in the demand for dollars and an increase in the supply of euros

A. A decrease in the demand for dollars
Explanation
When the Fed purchases euros, it effectively increases the supply of euros in the market. This increase in the supply of euros will lead to a decrease in the value of euros relative to dollars. As a result, individuals and businesses will have less demand for dollars and more demand for euros. Therefore, the impact on the foreign exchange market for dollars resulting from the Fed purchasing euros will be a decrease in the demand for dollars.

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• 15.

### 15. A foreign exchange intervention by a central bank affects the value of a country's currency because it:

• A.

Alters banking system reserves

• B.

Changes domestic interest rates

• C.

Results in a fixed exchange rate

• D.

Alters banking system reserves and it changes domestic interest rates

D. Alters banking system reserves and it changes domestic interest rates
Explanation
A foreign exchange intervention by a central bank affects the value of a country's currency because it alters banking system reserves and changes domestic interest rates. When a central bank intervenes in the foreign exchange market, it buys or sells its own currency to influence its value. This buying or selling of currency affects the banking system reserves, as the central bank either adds or removes currency from the system. Additionally, the central bank's actions can also impact domestic interest rates, as buying or selling currency can affect the supply and demand for money, leading to changes in interest rates.

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• 16.

### 16. Assume that the Fed performs a foreign exchange intervention in which it does nothing except buy German government bonds. One result of this will be that:

• A.

The dollar depreciates

• B.

The euro depreciates

• C.

Both the dollar and the euro depreciate

• D.

The dollar appreciates and the euro depreciates

A. The dollar depreciates
Explanation
When the Fed performs a foreign exchange intervention by buying German government bonds, it increases the demand for euros and decreases the supply of dollars in the foreign exchange market. This leads to a decrease in the value of the dollar relative to the euro, causing the dollar to depreciate.

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• 17.

### 17. A sterilized foreign exchange intervention would:

• A.

Alter the asset side of a central bank's balance sheet but leave the domestic monetary base unchanged

• B.

Alter the liability side of the central bank's balance sheet but leave the asset side unchanged

• C.

Leave the central bank's balance sheet unchanged

• D.

Not alter the central bank's holdings of international reserves

A. Alter the asset side of a central bank's balance sheet but leave the domestic monetary base unchanged
Explanation
A sterilized foreign exchange intervention refers to a central bank's action to buy or sell foreign currency in the foreign exchange market while simultaneously offsetting the impact on the domestic money supply. In this case, the intervention would alter the asset side of the central bank's balance sheet by increasing or decreasing its holdings of foreign currency, but it would not affect the domestic monetary base. This means that the central bank is able to influence the exchange rate without causing changes in the money supply or domestic interest rates.

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• 18.

### 18. If the Fed were to purchase euros for dollars and at the same time sell U.S. Treasury securities in the open market, this would be an example of:

• A.

An unsterilized foreign exchange intervention

• B.

The Fed not changing their balance sheet at all

• C.

A sterilized foreign exchange intervention

• D.

The Fed altering the domestic monetary base

C. A sterilized foreign exchange intervention
Explanation
A sterilized foreign exchange intervention refers to a situation where a central bank, in this case the Fed, purchases or sells foreign currency in the foreign exchange market while simultaneously conducting offsetting transactions to neutralize the impact on the domestic money supply. In this scenario, the Fed is purchasing euros for dollars and selling U.S. Treasury securities, which helps to offset the increase in the money supply that would have occurred due to the purchase of euros. This intervention aims to influence the exchange rate without affecting domestic monetary conditions.

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• 19.

### 19. In September of 2000, the Federal Reserve Bank of New York sold dollars in exchange for euro. To keep the federal funds rate on target, the Open Market desk:

• A.

Sold US treasury bonds

• B.

Bought US treasury bonds

• C.

Bought dollars

• D.

Sold dollars

A. Sold US treasury bonds
Explanation
To keep the federal funds rate on target, the Open Market desk sold US treasury bonds. Selling US treasury bonds reduces the money supply in the economy, which helps to increase interest rates and keep the federal funds rate in line with the target set by the Federal Reserve. By selling bonds, the Open Market desk is essentially taking money out of circulation, which helps to control inflation and stabilize the economy.

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• 20.

### 20. An advantage of fixed exchange rates for a country that suffers from bouts of high inflation is:

• A.

It makes imports less expensive

• B.

It establishes a credible low inflation policy

• C.

It unties policymakers' hands so they can alter the reserves of the banking system as needed

• D.

Policymakers will have increased control over domestic interest rates

B. It establishes a credible low inflation policy
Explanation
Fixed exchange rates can help establish a credible low inflation policy for a country that suffers from bouts of high inflation. When a country pegs its currency to another currency or a fixed value, it limits the ability of its central bank to print more money or engage in expansionary monetary policies that could lead to inflation. This commitment to maintaining a stable exchange rate can signal to investors and the public that the government is serious about controlling inflation, which can help build confidence in the country's monetary policy and reduce inflation expectations.

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• 21.

### 21. A fixed exchange rate policy:

• A.

Decreases central bank policy accountability and transparency

• B.

Strengthens domestic interest rate policy

• C.

Will likely make domestic inflation more volatile

• D.

Imports monetary policy

D. Imports monetary policy
Explanation
A fixed exchange rate policy imports monetary policy from other countries. This means that changes in the exchange rate are determined by the central bank's actions in response to changes in the foreign exchange market. Therefore, the domestic interest rate policy is strengthened as it is influenced by the exchange rate policy. Additionally, a fixed exchange rate policy can make domestic inflation more volatile as it limits the ability of the central bank to adjust interest rates to control inflation.

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• 22.

### 22. A country with a fixed exchange rate policy that is experiencing an economic slowdown will find:

• A.

Their central bank will reduce the domestic interest rate in order to fend off the slowdown

• B.

Their currency will depreciate to stimulate exports

• C.

Their bonds will become less attractive to foreign investors

• D.

The stabilization mechanism that policy makers could have used is completely shut down

D. The stabilization mechanism that policy makers could have used is completely shut down
Explanation
When a country with a fixed exchange rate policy is experiencing an economic slowdown, the stabilization mechanism that policy makers could have used is completely shut down. This means that they are unable to adjust their exchange rate to stimulate their economy. In a fixed exchange rate system, the value of the currency is pegged to another currency or a basket of currencies, and the central bank has to maintain this fixed rate. As a result, the country cannot devalue its currency to make exports more competitive or adjust interest rates to stimulate economic activity. This lack of flexibility can hinder the country's ability to address economic slowdowns effectively.

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• Mar 19, 2023
Quiz Edited by
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• May 08, 2012
Quiz Created by
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