ECON 321 Final Exam Ch. 14

Other nominal anchors or targets, such as rules for monetary growth, sometimes fail to optimize economic conditions in the short run because:

low monetary growth may curb inflation but may also constrain growth of real income.

If all else is equal, a nation with greater income will have:

lower prices.

During the economic crisis of 2008-2010, efforts to keep inflation pinned at 2%:

made things more difficult, since real interest rates cannot fall below zero.

When there is a hyperinflationary period, large changes in exchange rates and price levels happen ________ during periods of more stable prices and exchange rates.

much more rapidly than

Factors that could weaken the relationship between money growth rates and changes in price levels and rates of exchange include:

national differences in variables affecting growth of real income or the demand for money.

In general, monetary economic theory states that the demand for money is proportional to:

nominal income.

If the Fisher effect holds (when a nation's nominal rate of interest equals the world interest rate plus the nation's own expected inflation rate), then keeping the ____ fixed would force nations to keep inflation stable.

nominal interest rate

In the long run, the demand for real balances rises whenever:

nominal interest rates fall and real GDP rises.

The price level in the country is determined by ______ and _______.

nominal money supply; demand for real money

If the U.S. growth rate is greater than that of Canada, then the dollar will depreciate:

only if the U.S. inflation rate exceeds Canada's.

The long-run monetary model of exchange rates provides that real income changes result in a(n) _______ change in the price level and a(n) ________ change in the strength of the currency.

opposite; corresponding

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. With the price of the computer given in the local currency, the Brazilian real is _______ by _____%.

overvalued; 9.1

The law of one price requires:

perfect competition.

The demand for real money balances is:

proportional to real income.

In the international goods market, prices of goods in different countries expressed in a common currency must be equalized. This concept is called ______.

purchasing power parity (PPP)

If we adjust the supply of money for changes in the price level, we get real balances. The demand for real balances is proportional to ____.

real GDP

If prices are flexible and PPP holds, it is possible to forecast the exchange rate in the long run whenever ______ change in a nation ceteris paribus.

real income and nominal growth rate of the money supply

Real interest parity indicates that, when PPP and UIP hold:

real interest rates are equal across countries.

When real interest parity holds:

real interest rates are equal across nations with different currencies.

Evidence on the existence of relative PPP shows that:

relative PPP is an approximate guide to predicting the relationship between changes in inflation and exchange rates over long periods such as decades.

Whenever two nations experience inflation, and the nominal exchange rates move by the same percentage to offset, we say there is:

relative PPP.

Currency reform refers to:

replacing currency whose value has fallen with new units of higher value.

Price stickiness refers to:

slow movements in prices.

Evidence suggests that convergence to PPP occurs:

slowly, as arbitrageurs operate, and production, prices, and exchange rates adjust.

Economists have developed models to predict changes in exchange rates based on inflation trends. To forecast exchange rates, economists calculate the average ____.

speed of convergence

Question Globalization trends may ____ the tendency for prices to converge.

speed up

Empirically, during the period 1975-2005, the relationship between the growth rate of money, changes in the price level, and changes in the exchange rate was:

strong but not perfect.

Evidence on hyperinflationary periods indicates:

that the relationship between high inflation and exchange depreciation is much tighter even in the short run.

In which decade did the use of nominal anchors and explicit targets begin to be common in many nations?

the 1990s

If a nation uses one or a combination of nominal anchors, a trade-off is that it loses:

the ability to control its own monetary-related variables, such as various interest rates, which might affect its economy adversely.

The entity in any nation that accurately controls directly or indirectly the supply of money is referred to as:

the central bank.

If nominal income in a nation decreases, economists would predict:

the demand for money will decrease.

A lesson from hyperinflationary periods is that:

the demand for real money balances decreases during periods of extreme instability.

Combining the relative PPP with the monetary model of exchange rates, we find: the rate of depreciation of a currency (relative to another nation) in the long run is equal to:

the difference between the nominal money supply growth rates in each nation minus the difference between growth rates of real GDP.

Even though we assume the nominal interest rate on money is zero, there is a benefit to holding money. This is generally thought to be:

the ease of conducting transactions by having a perfectly liquid payment system.

In equilibrium, all traded goods sell at the same price internationally. If the same goods are expressed in their home prices, then the ratio of the prices is equal to:

the exchange rate between the two currencies.

Under the monetary approach to exchange rates, if the exchange rate has appreciated, this suggests that:

the foreign country's money supply has risen.

Under the monetary approach to exchange rates, if the exchange rate has appreciated, this suggests that:

the home country's money supply has fallen.

When we incorporate a relationship between expected inflation and liquidity preference (demand for real balances) into our long-run model, the results change as follows:

the increase in interest rates and inflation after a change in the monetary growth rate affect exchange rates but also cause secondary effects on exchange rates and price levels because of a decrease in the demand for real balances.

The cost of holding money is primarily:

the interest given up by not investing it.

If inflation in the United States is 4% per year and in the United Kingdom it is 8% per year, and interest rate in the United Kingdom is 6%, then the Fisher effect predicts that:

the interest rate in the United States is 2%.

The idea that with frictionless trade all goods traded internationally will have the same equilibrium price no matter which currency they are priced in, is known as:

the law of one price.

In the general model of the demand for money, the demand for real balances is based on which two variables?

the level of real income and the nominal rate of interest

The real interest rate is equal to:

the nominal interest rate minus inflation.

For a given level of real income, the demand for real money balances is inversely related to:

the nominal rate of interest.

Whenever the supply of money is growing at a constant rate, if there is price flexibility and real income is constant, then:

the price level grows at the same rate.

According to the long-run monetary model, we can rearrange terms in the money demand/supply in our long-run relationship to show that when the nominal supply of money is increased ceteris paribus:

the price level is increased.

Absolute purchasing power parity implies that:

the price of a basket of goods is the same in the two countries.

Using monetary theory, one can show that the price level (index) in an economy is equal to:

the ratio of the nominal supply of money to the demand for real balances.

In equilibrium, with purchasing power parity, the nominal exchange rate will be equal to:

the ratio of the two nations' price levels.

While the law of one price relates prices on individual goods to the exchange rate, the theory of PPP relates:

the relative price level of a basket of goods to the exchange rate.

The difference between the simple model and the general model of exchange rate determination in the long run is that:

the simple model assumes a constant demand function for real balances, while the general model assumes that the demand for real balances is a decreasing function of the nominal interest rate.

The relative purchasing power of a currency is:

the value of one currency in terms of the goods and services a unit will purchase compared to an equivalent amount of another currency.

The primary difference between the simple quantity theory of money and one in which interest rates matter is that with the more general model:

there are jumps in exchange rates.

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. With the price of the computer given in the local currency, the South African rand is _______ by _____%.

undervalued; 12.5

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. With the price of the computer given in local currency, the Indian rupee is _____ by ______%.

undervalued; 20

The criterion for including an asset in any measure of money is whether it is:

used for transactions and highly liquid.

If we assume that prices adjust in the long run so that the nominal demand for money equals the nominal supply of money, then:

we can determine changes in exchange rates if absolute PPP holds.

If a pair of Nike shoes cost $45 in New York and $65 in Berlin, then:

we would expect the price to increase in New York and decrease in Berlin.

Short-run PPP may not hold for a variety of reasons. Which of the following is NOT cited in your textbook as one of those reasons?

weather and other environmental conditions that affect trade

Under what circumstances would there be a "no-arbitrage" situation in goods markets between two nations?

when the relative price of the currencies is equal to one

If PPP and uncovered interest parity hold, then the long-run real rate of interest in each nation:

will equalize.

When the relative price of a good in Germany versus the United States is 3, if the nominal exchange rate is E$/€=1.5 and the U.S. price is $10, what is the German price?

€20

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. According to the information provided, under conditions of PPP, the price of a computer should be ____ reais in Brazil.

1,100

When the law of one price holds, the real exchange rate is always equal to:

1.

Whenever the absolute purchasing power of two currencies is the same, the real exchange rate between them is equal to:

1.

When the price of a good in the United States is $2, in Spain is €2, and the nominal exchange rate is E$/€=1.5, what is the relative price of the good in Spain versus the United States?

1.5

If a basket of goods in the United States costs $1,000, and the same basket of goods in Japan costs ¥125,000, then for PPP to exist, $1 should trade for ____ Japanese yen.

125

With an annual inflation of 3.5%, prices will double in _____ years, and if inflation increases to 10%, prices will double in _______ years.

20; 7

If an automobile costs $32,000 in New York and $1 = 0.8 euros, then under the condition of the law of one price, the cost of the automobile in Rome should be:

25,600 euros.

If a pound of coffee beans costs 85 pesos in Mexico City and 10 pesos = 35 rupees, then the same pound of coffee should cost _________ in New Delhi, under the condition of the law of one price.

297.50 rupees

The half-life of PPP deviations is about:

4 years.

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. If PPP were to hold, then the price of a computer in South Africa would be _____ rands.

4,000

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. If PPP were to hold, then the price of a computer in Mexico would be _____ pesos.

5,000

Purchasing power parity exists when:

All of the answers are correct.

Of the following targets or nominal anchors, which is NOT useful for controlling domestic inflation?

All of the these are useful in controlling domestic inflation.

Incorporating the liquidity preference function into the simple model changes its outcome somewhat. What is the impact?

Changes in the growth of the money supply cause inflation and nominal interest rates to change, which affects demand for real balances and causes further discontinuous impacts on prices.

How could conditions of imperfect competition explain deviations from PPP?

Imperfect competition means that prices are higher than costs and may not converge.

If a nation experiences 10% inflation and its trading partner does not, and if PPP holds, what happens to its nominal exchange rate?

It depreciates by 10%.

If a nation experiences 10% inflation and its trading partner does not, and if PPP holds, what happens to its real exchange rate?

It does not change.

What is the Big Mac index?

It is an index of the price of McDonald's hamburgers quoted in one currency designed to measure whether absolute PPP holds for Big Macs.

If the real exchange rate for a foreign currency falls (a real appreciation), what is the situation?

It takes fewer home goods to purchase the same quantity of foreign goods.

If the real exchange rate for a foreign currency rises (a real depreciation), what is the situation?

It takes more home goods to purchase the same quantity of foreign goods.

Which of the following nations has NOT suffered bouts of extreme hyperinflation?

Japan

When the Japanese inflation rate is less than the Australian inflation rate:

Japanese prices are rising more slowly than Australian prices.

The most restrictive measurement of money is:

M0

Currency is a part of which measure of money?

M0, M1, and M2

The broad measure of money is referred to as:

M2

Absolute PPP and relative PPP differ in what way?

Relative PPP may hold even when absolute PPP does not.

Which of the following statements about the relationship between money, prices, and exchange rates in the long run is NOT correct?

Since money is neutral in the long run, real income growth has no effect on inflation or the nominal exchange rate for a nation.

If Europe has a real GDP growth rate of 5%, and the United States has a real GDP growth rate of 6%, while money growth in Europe is 7%, and money growth in the United States is 5%, what would the monetary exchange rate model predict for exchange rates in the long run?

The U.S. dollar would appreciate by 3% against the euro.

What is the situation when a home currency purchases fewer goods and services at home than abroad when converted to a foreign currency?

The currency is overvalued.

What is the situation when a home currency purchases more goods and services at home than abroad when converted to a foreign currency?

The currency is undervalued.

According to Sterne's article, have nominal anchors used by various nations been effective in the real world?

Yes, for the most part. Central banks have become more independent, and inflation rates have fallen on average.

According to the quantity theory of money, the demand for money is equal to:

a constant proportion of nominal income.

The long-run Fisher effect links rises in inflation with rises in nominal interest rates by the same proportion, resulting in ____ the demand for real money balances.

a decrease in

Economists consider high and volatile inflation to be:

a negative factor in economic growth, as firms and workers deal with uncertainty about profitability, investments, and wages.

If fewer home goods are required to buy the same amount of foreign goods, then we say that foreign currency has experienced:

a real appreciation.

If more home goods are required to buy the same amount of foreign goods, then we say that foreign currency has experienced:

a real depreciation.

If the exchange rate between the dollar and yen has risen, this would be consistent with:

a rise in the U.S. interest rate, a rise in U.S. inflation, and a fall in the Japanese interest rate.

Hyperinflation is a condition described by:

a sustained increase in price of 50% each month.

Money can be defined as:

a unit of account, a store of value, and a medium of exchange.

Considering data on exchange rate and price-level fluctuations in the United States and the United Kingdom from 1975 to 2009, it is clear that:

absolute and relative PPP hold in the long run.

Assume nominal GDP = PY, and k = the proportion of nominal income that the nation holds (demands) as money to cover its transactions. Because nominal money supply = nominal money demand, then:

an increase in the money supply causes a proportional increase in nominal income.

We can use the existence of arbitrage and the idea of uncovered interest parity (UIP) to assume that any interest rate differential between two currencies must be offset by:

an offsetting differential in the expected exchange rates.

In equilibrium, all traded goods sell at the same price internationally because of:

arbitrage.

Better communication technology has made it easier to conduct ____ in international markets, thus ____ exchange rate adjustments to economic conditions and inflation.

arbitrage; speeding up

The long-run monetary model of the price level provides that:

as long as prices are flexible, a change in the supply of money or the demand for money will result in a change in the price level to restore equilibrium.

Forecasting exchange rates involves:

assessing data on money supply growth and potential real income growth.

If prices are held constant and income increases by 12%, the demand for money will ______ by _______%.

increase; 12

The Fisher effect creates a link between _____ and ______.

inflation rates; interest rates

Money's function as a medium of exchange is important because:

it eliminates the need for inefficient barter.

Under the monetary approach to exchange rates, if real money demand is greater at home but relative money supply is greater in foreign markets, then the exchange rate should be:

less than 1.

The monetary approach to exchange rates describes:

long-run relationships between money, prices, and exchange rates.

Economists consider central bank independence to be a key factor in keeping inflation under control. Why?

Elected officials (legislators and the executive branch) tend to pursue policies popular with the public that may increase inflationary tendencies, whereas the Central Bank does not have such pressure.

Which of the following situations would exhibit relative PPP?

Europe's yearly inflation rate rises from 5% to 7%, ceteris paribus, and the euro-yen rate depreciates by 2%.

Combining the concepts of uncovered interest parity (UIP) and relative purchasing power parity (PPP), the ________ shows that differences in inflation rates between two nations will be equal to the difference in their nominal rates of interest.

Fisher effect

The law of one price works under some assumptions. Which of the following is NOT an assumption for the law of one price?

The skill level of workers is identical in both countries.

Which of the following statements is NOT a reason for explaining the deviations from PPP?

There are no transportation costs.

Under the monetary approach to exchange rates, if both real money demand and money supply are greater at home than in foreign markets, then the exchange rate should be:

There is not enough information provided to know what the exchange rate should be.

The M1 measure of money includes demand deposits but excludes:

bank reserves.

If U.S. real income increases, then the prediction of the monetary model of exchange rates would be that the U.S. dollar would:

become stronger.

Zimbabwe's ability to limit hyperinflation was hindered by:

black markets.

For real interest parity to hold, we require:

both PPP and UIP.

When the inflation rate in any nation changes ceteris paribus:

both absolute and relative PPP are disturbed.

If we can accurately predict monetary growth, and if the assumption that demand for real money balances is constant, then we may predict:

both changes in price levels and changes in exchange rates.

The long-run relationship between money growth, income growth, and the change in the price level in a nation is:

change in the price level = money growth - real income growth.

Using the relationship between expected exchange rates and inflation differentials in combination with uncovered interest parity, we find:

changes in inflation rates are directly related to changes in nominal interest rates.

More realistically, the liquidity function is not ______ but a(n) ______ function of the demand for real balances based on changes in the ______.

constant; decreasing; nominal rate of interest

If conditions hold for the long-run monetary exchange rate model, it can provide opportunities for nations to achieve less price-level volatility by:

constraining policy choices to respect a nominal anchor, such as a target for a nominal exchange rate.

As economies adjust to inflation, there is an adjustment of exchange rates to reflect the changed price level. This adjustment is called:

convergence.

It is not surprising to learn that, during hyperinflations, the demand for real money balances:

decreases as the value of the nominal money decreases.

Under the monetary approach to exchange rates, if there is a rise in a country's home money supply, and all else is equal, then the exchange rate should:

depreciate

An increase in money supply by 15% in the United States would cause the exchange rate to:

depreciate by 15%.

If there is an increase in the money supply in the United States, using the monetary model of the exchange rate, one would predict that the U.S. dollar would:

depreciate.

Under the monetary approach to exchange rates, if there is a rise in a foreign market's income, and all else is equal, then the exchange rate should:

depreciate.

With relative PPP, a rise in a nation's inflation rate is always offset by an increase in the rate of __________ of its currency.

depreciation

When we incorporate a relationship between expected inflation and liquidity preference (demand for real balances) into our long-run model, it can help to explain:

erratic shifts in exchange rates, how changes in expectations can move the markets quickly, and why sometimes PPP seems not to hold in the short run.

When the Chinese yuan is appreciating against the U.S. dollar, if relative PPP holds, then this suggests that the U.S. inflation rate:

exceeds the Chinese inflation rate.

If money growth is bigger than income growth, then we can:

expect inflation to increase.

If the prices of goods in Europe increase, while the nominal exchange rate between the euro and the U.S. dollar has not changed, we say that the U.S. dollar has:

experienced a real depreciation.

Nominal anchors restrain inflation and rising interest rates by:

forcing restrictions on easy monetary policies.

When we consider growth rates of the variables, the growth of the price level (inflation) is equal to:

growth of the nominal supply of money minus the growth rate of real income.

An example of a non-traded product would be:

haircuts.

Data indicates that the Fisher effect:

holds in neither the long run nor the short run.

The half-life of a PPP divergence indicates:

how long it takes for half to disappear.

The nominal exchange rate between two currencies tells us:

how many units of one currency can be purchased with one unit of the home currency.

The real exchange rate between two currencies tells us:

how much in terms of goods and services the home currency will buy in the foreign nation compared to the home nation.