ECO FINAL EXAM

15. Why would lowering its own interest rates affect a nation's exchange rate? A) International interest arbitrage (the ability to borrow in low-rate markets and deposit in higher-rate markets) would cause investors to sell domestic currency assets and purchase foreign assets based in other currencies. B) A nation's central bank controls both interest rates and exchange rates. Unfortunately, they do not have sufficient funds to take care of both at the same time. C) When interest rates fall, borrowing is cheaper, spending and GDP rise and so do exports, thus causing the exchange rate to appreciate. D) In the short run, exchange rates have to adhere to PPP; otherwise, traders will make profits by purchasing in the cheap market and selling in the more expensive market, thus aligning exchange rates at the proper level.

A) International interest arbitrage (the ability to borrow in low-rate markets and deposit in higher-rate markets) would cause investors to sell domestic currency assets and purchase foreign assets based in other currencies.

During the period 2001-2004, the U.S. Federal Reserve lowered nominal interest rates on the dollar by more than the European Central Bank (ECB) did on the euro, a move that most market participants viewed as temporary. What was the effect on the dollar-euro exchange rate? A) The dollar depreciated against the euro. B) The dollar appreciated against the euro. C) There was no change in the dollar-euro rate because expectations adjusted. D) There was no change in the dollar-euro rate because real interest rates were unchanged.

A) The dollar depreciated against the euro.

5. When traders perceive a permanent money supply adjustment, long-term nominal interest rates ___ affected, the expected exchange rate ____ affected, and the spot exchange rate _____ affected. A) are not; is; is B) are; is; is not C) are not; is not; is not D) are; is not; is

A) are not; is; is

6. When traders perceive a permanent money supply adjustment, short-term nominal interest rates ___ affected, the expected exchange rate ____ affected, and the spot exchange rate _____ affected. A) are; is; is B) are; is; is not C) are not; is not; is not D) are; is not; is

A) are; is; is

11. When an increase in the quantity of money is considered to be permanent and prices are sticky, then in the short run the exchange rate depreciates and overshoots because: A) domestic nominal returns fall relative to foreign returns, and traders expect a permanent depreciation in future exchange rates. B) traders do not change their expectations of the exchange rate, and lower domestic rates make it easier to borrow. C) inflationary expectations eventually cause a rise in domestic real returns. D) traders quickly realize that their expectations of future exchange rates are incorrect and eventually prices will become unstuck.

A) domestic nominal returns fall relative to foreign returns, and traders expect a permanent depreciation in future exchange rates.

3. When there is a permanent fall in the domestic money supply, the exchange rate: A) falls in the short run and rises slightly in the long run. B) falls in the short run and falls more in the long run. C) rises in the short run and falls slightly in the long run. D) rises in the short run and rises more in the long run.

A) falls in the short run and rises slightly in the long run.

14. With fixed exchange rates and capital mobility: A) interest rates in the home country and in foreign countries are equalized. B) interest rates in the home country are higher. C) interest rates in foreign countries are higher. D) monetary policy maintains its autonomy.

A) interest rates in the home country and in foreign countries are equalized.

2. The asset approach basically looks at ____ as the fundamental variable affecting _____ exchange rates. A) interest rates; short-run B) interest rates; long-run C) the price level; short-run D) the price level; long-run

A) interest rates; short-run

8. When the exchange rate depreciates in the short run and then appreciates to its original level in the long run, it implies that the domestic money supply has: A) temporarily risen. B) permanently risen. C) temporarily fallen. D) permanently fallen.

A) temporarily risen

13. Central banks control exchange rates by intervention. If a nation such as Japan wished to peg its market rate at a certain level, such as ¥100 = $1, what should it do if the actual market rate began to depreciate to ¥125 = $1? A) It should purchase dollars with its own currency. B) It should sell dollars from its treasury and retire its own currency. C) It should increase its GDP to increase exports. D) It should petition the IMF for a rate change.

B) It should sell dollars from its treasury and retire its own currency.

7. In the short run, the nominal interest rate is affected by changes in the money supply perceived to be temporary, but once ____ adjust(s), the nominal interest rate ____ in the long run. A) the supply of money; rises B) the price level; will revert to its former level C) expectations of interest rates; falls D) real GDP; does not change

B) the price level; will revert to its former level

9. If there is a permanent increase in the domestic money supply, then in the short run, which of the following will be TRUE? A) The prices will adjust lower. B) Domestic interest rates will increase. C) Real money supply will increase. D) Domestic money demand will permanently increase.

C) Real money supply will increase

12. Overshooting occurs because: A) expectations adjust slower than prices. B) expectations adjust at the same rate as prices. C) expectations adjust faster than prices. D) expectations do not adjust.

C) expectations adjust faster than prices.

4. When there is a permanent fall in the foreign money supply, the exchange rate: A) falls in the short run and rises slightly in the long run. B) falls in the short run and falls more in the long run. C) rises in the short run and falls slightly in the long run. D) rises in the short run and rises more in the long run.

C) rises in the short run and falls slightly in the long run.

10. If the Bank of Japan permanently increases its money supply, then which of the following is most likely to take place in the short run? A) Japanese prices will immediately decrease. B) Japanese prices will immediately increase. C) Japanese interest rates will increase. D) Japanese interest rates will decrease.

D) Japanese interest rates will decrease.

16. Why would making a permanent change in a monetary aggregate have an effect on exchange rates in a nation? A) Permanent rates are mostly set by short-run fluctuations in the rate of interest caused by monetary instability. B) A permanent change is never quite as permanent as policy makers claim—people form expectations on past performance rather than declarations. C) The central bank is always aware of the effect on exchange rates as it formulates policy, so it is very careful to make small permanent changes that have no effect on exchange rates. D) Traders form expectations of future exchange rates based on the anticipated long-run effects of monetary operations.

D) Traders form expectations of future exchange rates based on the anticipated long-run effects of monetary operations.