Chapter 7: Fixed Exchange Rates and Foreign Exchange Intervention

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1. Central banks often intervene in currency markets. This activity is called: -
managed floating
2. Which of the following is an example of a regional currency arrangement?

A) exchange rate union

B) currency cartel associations
C) free-trade zones
D) most-favored nation status
E) agreement on commercial trade: exchange rate union
3. Industrialized countries typically ________ their floating exchange rates.
Developing countries often ________ their floating exchange rates.: manage;
peg
4. A central bank's international reserves consists of its holdings of: foreign
assets and gold
5. The liabilities side of a central bank's accounts consists of: deposits held by
private banks and currency in circulation
6. Which one of the following statements is most correct?

A) Any central bank purchase of assets automatically results in an increase

in the domestic money supply, while any central bank sale of assets automat-
ically causes the money supply to decline.
B) Any central bank purchase of assets results in an increase in the domestic
money supply, while any central bank sale of assets causes the money supply
to decline.
C) Any central bank purchase of assets automatically results in a decrease in
the domestic money supply, while any central bank sale of assets automati-
cally causes the money supply to decline.
D) Any central bank purchase of assets automatically results in a decrease in
the domestic money supply, while any central bank sale of assets automati-
cally causes the money supply to increase.
E) Any central bank purchase of assets automatically results in an increase
in the domestic money supply, while any central bank sale of assets does
not necessarily affect the money supply.: Any central bank purchase of assets
automatically results in an increase in the domestic money supply, while any central
bank sale of assets automatically causes the money supply to decline.
7. Which one of the following statements is the most correct?

A) If central banks are not sterilizing and the home country has a balance of
payments surplus, any associated increase in the home central bank's foreign
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asset implies an increased home money supply.
B) If central banks are not sterilizing and the home country has a balance of
payments surplus, any associated increase in the home central bank's foreign
asset implies a decreased home money supply.
C) If central banks are not sterilizing and the home country has a balance of
payments surplus, any associated increase in the home central bank's foreign
asset implies an increased home money demand.
D) If central banks are not sterilizing and the home country has a balance of
payments surplus, any associated decrease in the home central bank's foreign
asset implies an increased home money supply.
E) If central banks are not sterilizing and the home country has a balance
of payments shortage, any associated decrease in the home central bank's
foreign asset implies an increased home money supply.: If central banks are not
sterilizing and the home country has a balance of payments surplus, any associated
increase in the home central bank's foreign asset implies an increased home money
supply
8. Which one of the following statements is most correct?

A) If central banks are not sterilizing and the home country has a balance of
payments surplus, any associated increase in a foreign central bank's claims
on the home country implies a decreased foreign money supply.
B) If central banks are not sterilizing and the home country has a balance of
payments surplus, any associated decrease in a foreign central bank's claims
on the home country implies a decreased foreign money demand.
C) If central banks are not sterilizing and the home country has a balance of
payments surplus, any associated decrease in a foreign central bank's claims
on the home country implies a decreased foreign money supply.
D) If central banks are not sterilizing and the home country has a balance
of payments shortage, any associated decrease in a foreign central bank's
claims on the home country implies a decreased foreign money supply.
E) If central banks are not sterilizing and the home country has a balance
of payments shortage, any associated decrease in a foreign central bank's
claims on the home country implies an increased domestic money supply: If
central banks are not sterilizing and the home country has a balance of payments
surplus, any associated decrease in a foreign central bank's claims on the home
country implies a decreased foreign money supply
9. A system of managed floating exchange rates is: a system in which gov-
ernments may attempt to moderate exchange rate movements without keeping
exchange rates rigidly fixed.
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10. Under fixed exchange rate, in general: the domestic and foreign interest rates
are equal, R = R(*).
11. Under fixed exchange rate, in general which one of the following state-
ments is the MOST accurate?

A) The following condition should hold for domestic money market equilibri-
um: Ms/P = L(R, Y).
B) The following condition should hold for domestic money market equilibri-
um: Md/P = L(R, Y).
C) The following condition should hold for domestic money market equilibri-
um: Ms = L(R, Y).
D) The following condition should hold for domestic money market equilibri-
um: P = L(R, Y).
E) The following condition should hold for domestic money market equilibri-
um: R*Md/P =L(Y).: The following condition should hold for domestic money market
equilibrium: Ms/P = L(R , Y).
12. Which one of the following statements is the MOST accurate?

A) Under a fixed exchange rate, central bank monetary tools are powerless to
affect the economy's money supply.
B) Under a flexible exchange rate, central bank monetary tools are powerless
to affect the economy's money supply or its output.
C) Under a fixed exchange rate, fiscal policy tools are powerless to affect the
economy's money supply or its output.
D) Under a fixed exchange rate, central bank monetary tools are powerless to
affect the economy's money supply or its output.
E) Under a dirty float exchange rate, central bank monetary tools are pow-
erless to affect the economy's money supply or its output.: Under a fixed
exchange rate, central bank monetary tools are powerless to affect the economy's
money supply or its output.
13. What is the expected dollar rate of return on dollar deposits if today's
exchange rate is $1.10 per euro, next year's expected exchange rate is $1.165
per euro, the dollar interest rate is 10%, and the euro interest rate is 5%?: 10%
14. By fixing the exchange rate, the central bank gives up its ability to: influence
the economy through monetary policy
15. Fiscal expansion under fixed exchange rates will have what temporary
effect?: the exchange rate will decrease
16. When a country's currency is devalued: both the output and the money supply
increases.
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17. Under fixed rates, which one of the following statements is the MOST
accurate?

A) Monetary policy can affect only output.

B) Monetary policy can affect only employment.
C) Monetary policy can affect only international reserves.
D) Monetary policy can not affect international reserves.
E) Monetary policy can only affect money supply.: Monetary policy can affect
only international reserves
18. Under fixed rates, which one of the following statements is the MOST
accurate?

A) Fiscal policy can affect output, employment and international reserves at

the same time.
B) Fiscal policy can affect only employment.
C) Fiscal policy can affect only international reserves.
D) Fiscal policy can affect only output and employment.
E) Fiscal employment can affect only output and international reserves.: Fiscal
policy can affect output, employment and international reserves at the same time.
19. Which one of the following statements is the MOST accurate?

A) Fiscal policy has the same effect on employment under fixed and flexible
exchange rateregimes.
B) Fiscal policy affects employment less under fixed than under flexible
exchange rate regimes.
C) Fiscal policy affects employment more under fixed than under flexible
exchange rate regimes.
D) Fiscal policy cannot affect employment under fixed exchange rate but does
affect output under flexible exchange rate regimes.
E) Fiscal policy can affect employment under fixed exchange rate regimes,
but does not affect output under flexible exchange rate regimes.: Fiscal policy
affects employment more under fixed than under flexible exchange rate regimes.
20. Which one of the following statements is the MOST accurate?

A) Fiscal policy has the same effect on output under fixed and flexible ex-
change rate regimes.
B) Fiscal policy affects output more under fixed than under flexible exchange
rate regimes.
C) Fiscal policy affects output less under fixed than under flexible exchange
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rate regimes.
D) Fiscal policy cannot affect output under fixed exchange rate but does affect
output under flexible exchange rate regimes.
E) Fiscal policy can affect output under fixed exchange rate but does not affect
output under flexible exchange rate regimes.: Fiscal policy affects output more
under fixed than under flexible exchange rate regimes.
21. Which one of the following statements is the MOST accurate?

A) A devaluation occurs when the central bank lowers the domestic currency
price of foreign currency, E, and a revaluation occurs when the central bank
raises E.
B) A devaluation occurs when the central bank raises the domestic currency
price of foreign currency, E, and a revaluation occurs when the central bank
lowers E.
C) Devaluation occurs when the domestic currency price of foreign currency,
E, raises and a revaluation occurs when E is lowered.
D) A devaluation occurs when the central bank of the foreign country raises
the domestic currency price of foreign currency, E, and a revaluation occurs
when the central bank of the foreign country lowers E.
E) A devaluation occurs when the central bank raises the foreign currency
price of domestic currency, E, and a revaluation occurs when the central bank
lowers E.: A devaluation occurs when the central bank raises the domestic currency
price of foreign currency, E, and a revaluation occurs when the central bank lowers
E.
22. Which one of the following statements is the MOST accurate?

A) Depreciation is a rise in E when the exchange rate is fixed while devaluation

is a rise in E when the exchange rate floats.
B) Depreciation is a decrease in E when the exchange rate floats while deval-
uation is a rise in E when the exchange rate is fixed.
C) Depreciation is a rise in E when the exchange rate floats while devaluation
is a rise in E when the exchange rate is fixed.
D) Depreciation is a rise in E when the exchange rate floats while devaluation
is a decrease in E when the exchange rate is fixed.
E) Depreciation is a fall in E when the exchange rate is fixed while devaluation
is a fall in E when the exchange rate floats.: Depreciation is a rise in E when the
exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.
23. Which one of the following statements is the MOST accurate?

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A) Appreciation is a rise in E when the exchange rate floats while revaluation
is a fall in E when the exchange rate is fixed.
B) Appreciation is a fall in E when the exchange rate floats while revaluation
is a fall in E when the exchange rate is fixed.
C) Appreciation is a fall in E when the exchange rate is fixed while revaluation
is a fall in E when the exchange rate is flexible.
D) Appreciation is a fall in E when the exchange rate floats while revaluation
is a rise in E when the exchange rate is fixed.
E) Appreciation is a rise in E when the exchange rate floats while revaluation
is a rise in E when the exchange rate is fixed.: Appreciation is a fall in E when
the exchange rate floats while revaluation is a fall in E when the exchange rate is
fixed.
24. Which one of the following statements is the MOST accurate?

A) Devaluation reflects a deliberate government decision.

B) Depreciation reflects a deliberate government decision.
C) Devaluation reflects a deliberate government decision while depreciation
is an outcome of government actions and market forces acting together.
D) Depreciation reflects a deliberate government decision while devaluation
is an outcome of government actions and market forces acting together.
E) Devaluation and depreciation have the same meaning and the same caus-
es.: Devaluation reflects a deliberate government decision while depreciation is an
outcome of government actions and market forces acting together.
25. Which one of the following statements is the MOST accurate?

A) Revaluation reflects an outcome of government actions and market forces

acting together while appreciation reflects a deliberate government decision.
B) Revaluation reflects a deliberate government decision while appreciation
is an outcome of government actions and market forces acting together.
C) Revaluation reflects a deliberate government decision while appreciation
is an outcome of government actions.
D) Revaluation and appreciation have the same meaning and the same caus-
es.
E) Appreciation reflects a deliberate government decision while revaluation is
an outcome of government actions and market forces acting together.: Reval-
uation reflects a deliberate government decision while appreciation is an outcome
of government actions and market forces acting together.
26. Under fixed exchange rates, which one of the following statements is the
MOST accurate?
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A) Devaluation causes a decrease in output, a decrease in official reserves,

and a contraction of the money supply.
B) Devaluation causes a rise in output, a rise in official reserves, and an
expansion of the money supply.
C) Devaluation causes a rise in output and a rise in official reserves.
D) Devaluation causes a rise in output and an expansion of the money supply.
E) Devaluation causes a rise in official reserves, and an expansion of the
money supply.: Devaluation causes a rise in output, a rise in official reserves, and
an expansion of the money supply.
27. Under fixed exchange rates, which one of the following statements is the
MOST accurate?

A) Devaluation causes a rise in output.

B) Devaluation causes a decrease in output.
C) Devaluation has no effect on output.
D) Devaluation causes a rise in output and a decrease in official reserves.
E) Devaluation causes a decrease in output and in official reserves.: Devalua-
tion causes a rise in output.
28. Under fixed exchange rates, which one of the following statements is the
MOST accurate?

A) Devaluation causes a reduction of the money supply.

B) Devaluation has no effect on the stock of money.
C) Devaluation causes an expansion of the money supply.
D) Devaluation causes a reduction in output.
E) Devaluation causes a reduction in official reserves: Devaluation causes an
expansion of the money supply.
29. The main reason(s) why governments sometimes chose to devalue their
currencies is (are): devaluation improves the current account and increases foreign
reserves held by the central bank.
30. A balance of payments crisis is best described as: a sharp change in foreign
reserves sparked by a change in expectations about the future exchange rate.
31. The expectation of future devaluation causes a balance of payments crisis
marked by: a sharp fall in reserves and a rise in the home interest rate above the
world interest rate
32. The expectation of future revaluation causes a balance of payments crisis
marked by: a sharp rise in reserves and a fall in the home interest rate below the
world interest rate
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33. capital flight: decreases reserves and may induce devaluation.
34. Currency crises may result from

A) central bank balance sheets with higher liabilities than assets.

B) political upheaval leading to lowering exports.
C) a reconfiguration of central bank balance sheets.
D) speculative attacks on the currency or central banks purchasing excessive
amounts of government bonds.
E) depreciation of foreign reserves.: speculative attacks on the currency or central
banks purchasing excessive amounts of government bonds.
35. Which of the following best describes a deliberate government decision to
lower the exchange rate, E?: revaluation
36. Imperfect asset substitutability assumes: the returns on foreign and domestic
currency differ and are influenced by risk.
37. The global financial crisis of 2007-2008 resulted in a(n) ________ of the
Swiss franc as foreign currency flowed ________ the country. As result, Swiss
products became ________ competitive in world markets.: appreciation; into;
less
38. The global financial crisis of 2007-2008 resulted in a(n) ________ of the
Swiss franc. In 2011, the Swiss central bank intervened in order to cause a(n)
________ of the franc.: appreciation; depreciation
39. Perfect asset substitutability is the assumption that: the foreign exchange
market is in equilibrium only when expected returns on domestic assets are equal
to returns on foreign currency bonds.
40. Imperfect asset substitutability exists: when there is risk in the foreign ex-
change market.
41. The interest parity condition can be written as: R = R* + (Ee - E)/E
42. When domestic and foreign currency bonds are imperfect substitutes, the
domestic interest rate (R) can be written as: R = R* + (Ee - E)/E + Á
43. In the interest rate parity condition with imperfect substitutes and a risk
premium of Á : an increased stock of domestic government debt will raise the differ-
ence between the expected returns on domestic and foreign currency bonds.
44. The signaling effect of foreign exchange intervention: can alter the market's
view of future monetary policies and cause an immediate exchange rate change
45. From 1837 and up until the Civil War, the United States adhered to a: -
bimetallic standard.
46. From the Civil War up to 1914, the United States adhered to a: gold standard
47. If assets are imperfect substitutes, then an increase in the amount of
domestic currency bonds held by the public will ________ the risk premium
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and ________ the amount of domestic currency bonds held by the central
bank: increase; leave unchanged
48. If assets are imperfect substitutes, then a decrease in the amount of
domestic currency bonds held by the public will ________ the risk premium
and ________ the amount of domestic currency bonds held by the central
bank.: decrease; leave unchanged
49. Balance of payments crises under fixed exchange rates occur because
of: government policies that are inconsistent with fixed exchange rates.
50. A balance of payments crises under fixed exchange rates occurs when: a
country runs out of foreign reserves

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