Chapter 18: The International Financial System

The fixed exchange rate regime established at a meeting in New Hampshire in 1944 has been known as the

Bretton Woods system.

Both France and the United Kingdom successfully used exchange-rate targeting to lower inflation in the late 1980s and early 1990s by tying the value of their currencies to the

German mark.

The Bretton Woods agreement created the ________, which was given the task of promoting the growth of world trade by setting rules for the maintenance of fixed exchange rates and by making loans to countries that were experiencing balance of payments difficulties.

IMF

This agency acts like an international lender of last resort to cope with financial instability.

IMF

Under the Bretton Woods system, the organization assigned the task of making loans to countries that were experiencing balance of payments difficulties is known as the

International Monetary Fund.

Which of the following is NOT an advantage to exchange-rate targeting?

It increases the accountability of policymakers.

Which of the following is NOT a disadvantage of exchange-rate targeting?

It relies on a stable money-inflation relationship.

Which of the following is not included in the current account?

Net acquisition of financial assets.

Which of the following is NOT a disadvantage of controls on capital outflows?

The controls may lead to excessive risk taking by the domestic banks.

Suppose that the Bank of Japan buys yen-denominated assets with U.S. dollar assets. Everything else held constant, this transaction will cause ________ in the foreign assets held by the Federal Reserve and ________ in the U.S. monetary base.

a decrease; a decrease

From 1994 to 2005, China chose to have ________ and ________ and therefore, could not have free capital mobility at the same time.

a fixed exchange rate; an independent monetary policy

Which of the following does NOT appear in the current account part of the balance of payments?

a loan of $1 million from Bank of America to Brazil

Which of the following appears in the financial account?

a purchase by the Honda corporation of a U.S. Treasury bill

A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called

a sterilized foreign exchange intervention.

Under a fixed exchange rate regime, a central bank that does not want to acquire international reserves to keep its currency from ________ will decide to ________ its currency.

appreciating; revalue

Everything else held constant, if a central bank makes an unsterilized sale of foreign assets, then the domestic money supply will ________ and the domestic currency will ________.

decrease; appreciate

Under the Bretton Woods system, when a country adopted an expansionary monetary policy, thereby causing a balance of payments ________, the country would eventually be forced to implement ________ monetary policy.

deficit; contractionary

Under the current managed float exchange rate regime, countries with balance of payments ________ frequently do not want to see their currencies ________ because it makes foreign goods more expensive for domestic consumers and can stimulate inflation.

deficits; depreciate

Because the United States was the reserve-currency country under the Bretton Woods system, it could run large balance of payments ________ without ________ significant amounts of international reserves.

deficits; losing

In response to the overvalued dollar in the early 1970s, the German Bundesbank bought ________ and sold ________ to keep the exchange rate fixed, gaining international reserves.

dollars; marks

Under a fixed exchange rate regime, if a central bank must intervene to purchase the ________ currency by selling ________ assets, then, like an open market sale, this action reduces the monetary base and the money supply, causing the interest rate on domestic assets to rise.

domestic; foreign

Under a fixed exchange rate regime, if the domestic currency is initially undervalued, that is, above par, the central bank must intervene to sell the ________ currency by purchasing ________ assets.

domestic; foreign

If a central bank does not want to see its currency rise in value, it may pursue ________ monetary policy to ________ the domestic interest rate, thereby weakening its currency.

expansionary; lower

If the United States has a current account deficit with England of $1 million, and the Bank of England sells $1 million worth of pounds in the foreign exchange market, then England ________ $1 million of international reserves and its monetary base ________ by $1 million.

gains; rises

Policymakers in a country with a balance of payments surplus may not want to see their country's currency appreciate because this would

hurt domestic businesses by making foreign goods cheaper in their country.

Of the following, the one that appears in the current account of the balance of payments is

income earned by U.S. subsidiaries of Barclay's Bank of London.

Everything else held constant, if a central bank makes an unsterilized purchase of foreign assets, then the domestic money supply will ________ and the domestic currency will ________.

increase; depreciate

When Americans ________ their net holdings of foreign assets, this change is recorded as a net U.S. acquisition of financial assets in the financial account. When foreigners ________ their net holdings of U.S. assets, this change is recorded as a net U.S. incurrence of liabilities.

increase; increase

A current account surplus indicates that America is ________ its claims on foreign wealth, while a deficit indicates that this country is ________ its claims on foreign wealth.

increasing; reducing

The German central bank gained international reserves in the early 1970s because it sold ________ to prevent mark ________.

marks; appreciation

Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the German central bank was required to buy ________ and sell ________, thereby ________ international reserves.

pounds; marks; gaining

Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

pounds; marks; losing

If a central bank does not want to see its currency ________ in value, it may pursue expansionary monetary policy to lower the domestic interest rate, thereby ________ its currency.

rise; weakening

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will ________ and the domestic currency will appreciate.

sale; decrease

When gold production was low in the 1870s and 1880s, the money supply grew ________ causing ________.

slowly; deflation

Under the current managed float exchange rate regime, countries with ________ in their balance of payments frequently do not want to see their currencies ________ because it makes their goods more expensive abroad and foreign goods cheaper in their countries.

surpluses; appreciate

The difference between merchandise exports and imports is called the ________ balance.

trade

Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________ par, the central bank must intervene to sell the domestic currency by purchasing foreign assets.

undervalued; above

Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central bank's attempt to keep its currency from appreciating will result in a ________ of international reserves.

undervalued; gain

Under a gold standard in which one dollar could be turned in to the U.S. Treasury and exchanged for 1/20th of an ounce of gold and one Swiss Franc could be exchanged for 1/100th of an ounce of gold, an exchange rate of ________ francs to the dollar would stimulate a flow of gold from the United States to Switzerland.

4

If a central bank does not want to allow the domestic currency to appreciate, it will ________ international reserves by selling its currency, thereby ________ the monetary base and increasing the risk of higher inflation.

acquire; increasing

Under an exchange-rate targeting rule for monetary policy, a crawling peg

allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be higher than that of the anchor country.

Suppose that the Bank of Japan buys U.S. dollar assets with yen-denominated assets. Everything else held constant, this transaction will cause ________ in the foreign assets held by the Federal Reserve and ________ in the U.S. monetary base.

an increase; an increase

When the central bank allows the purchase or sale of domestic currency to have an effect on the monetary base, it is called

an unsterilized foreign exchange intervention.

Countries with surpluses in their balance of payments frequently do not want to see their currencies ________ because it makes their goods ________ expensive abroad.

appreciate; more

Under a fixed exchange rate regime, if a country has an undervalued exchange rate, then its central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.

appreciating; gain

In September 1992, the Bundesbank attempted to keep the mark from appreciating relative to the British pound, but it failed because participants in the foreign exchange market came to expect the

appreciation of the mark.

Exchange-rate targeting allows a central bank to ________, thus this will ________ the probability of policy developing a time-inconsistency problem.

be governed by a policy rule; decrease

A case for capital inflow controls can be made because capital inflows

can cause a lending boom and lead to excessive risk taking.

Two reasons for an industrialized country to adopt an exchange-rate targeting regime are if the country ________ conduct successful monetary policy on its own, and if the country wants to ________ integration of the domestic economy with its neighbors.

cannot; encourage

If a central bank does not want to see its currency fall in value, it may pursue ________ monetary policy to ________ the domestic interest rate, thereby strengthening its currency.

contractionary; raise

To keep from running out of international reserves under the Bretton Woods system, a country had to implement ________ monetary policy to ________ its currency.

contractionary; strengthen

The account that shows a country's current international transactions (that is, transactions that do not involve the purchase or sale of financial assets) for a given year is called the

current account.

In the early 1970s, the U.S. ran large balance of payments ________, causing an ________ dollar and an ________ German mark.

deficits; overvalued; undervalued

An international lender of last resort creates a serious moral hazard problem because ________ and other ________ of banking institutions expect that they will be protected if a crisis occurs.

depositors; creditors

Countries with balance of payments deficits do not want to see their currencies ________ because it makes foreign goods ________ expensive for domestic consumers.

depreciate; more

Under a fixed exchange rate regime, if a country's central bank runs out of international reserves, it cannot keep its currency from

depreciating.

Under a fixed exchange rate regime, a country that depletes its international reserves in an attempt to keep its currency from ________ will be forced to ________ its currency.

depreciating; devalue

Under a fixed exchange rate regime, if a country has an overvalued exchange rate, then its central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.

depreciating; loss

Under exchange-rate targeting, the central bank in the targeting country ________ lose the ability to pursue its own independent monetary policy and any shocks to the anchor country is ________ transmitted to the targeting country.

does; directly

Under a fixed exchange rate regime, if the domestic currency is initially overvalued, that is, below par, the central bank must intervene to purchase the ________ currency by selling ________ assets

domestic; foreign

The current international financial system is a managed float exchange rate system because

exchange rates fluctuate in response to, but are not determined solely by, market forces.

A monetary policy strategy that uses a fixed exchange rate regime that ties the value of a currency to the currency of a large, low inflation country is called ________ targeting.

exchange-rate

If a central bank does not want to see its currency ________ in value, it may pursue contractionary monetary policy to raise the domestic interest rate, thereby ________ its currency.

fall; strengthening

The account that shows international transactions that involve the purchase or sale of assets is called the

financial account.

Under the current managed float exchange rate regime, countries with balance of payments deficits frequently do not want to see their currencies depreciate because it makes ________ goods more expensive for ________ consumers and can stimulate inflation.

foreign; domestic

The Policy Trilemma states that a country or a monetary union can't pursue the following three policies at the same time

free capital mobility, a fixed exchange rate, and an independent monetary policy

Hong Kong chooses to have ________ and ________ and therefore, cannot have an independent monetary policy at the same time.

free capital mobility; a fixed exchange rate

The United States chooses to have ________ and ________ and therefore, cannot have a fixed exchange rate at the same time.

free capital mobility; an independent monetary policy

In response to the overvalued dollar in the early 1970s, the German Bundesbank bought dollars and sold marks to keep the exchange rate fixed, gaining international reserves. The huge purchase of international reserves meant that the German monetary base began to ________, leading to ________ growth in the German money supply.

grow; rapid

Because sterilized interventions mean offsetting open market operations, there is no impact on the monetary base and the money supply, and therefore a sterilized intervention

has no effect on the exchange rate.

Because central banks have not been willing to give up their option of intervening in the foreign exchange market, the current international financial system can best be described as a

hybrid of a fixed exchange rate and flexible exchange rate system.

A capital ________ can promote financial instability in an emerging-market country because it can lead to a lending boom and excessive risk-taking on the part of banks, which helps trigger a ________.

inflow; financial crisis

An advantage to exchange-rate targeting is it helps keep inflation under control by tying the inflation rate for ________ traded goods to what is found in the ________ country.

internationally; anchor

Since the abandonment of the Bretton Woods system, balance of payments considerations have become ________ important, and exchange rate considerations ________ important in the conduct of monetary policy.

less; more

If a central bank does not want to allow the domestic currency to depreciate, it will ________ international reserves by purchasing its currency, thereby ________ the monetary base and increasing the risk of higher unemployment.

lose; decreasing

A balance of payments deficit is associated with a ________ of international reserves, while a balance of payments surplus is associated with a ________.

loss; gain

The World Bank is an international organization that

makes loans to countries to finance projects such as dams and roads.

Under the Exchange Rate Mechanism of the European Monetary System, when the German mark depreciated below its lower limit against the British pound, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

marks; pounds; gaining

Under the Exchange Rate Mechanism of the European Monetary System, when the German mark depreciated below its lower limit against the British pound, the German central bank was required to buy ________ and sell ________, thereby ________ international

marks; pounds; losing

An international lender of last resort creates a serious ________ problem because depositors and other creditors of banking institutions expect that they will be protected if a crisis occurs.

moral hazard

Under the current managed float exchange rate regime; countries with surpluses in their balance of payments frequently do not want to see their currencies appreciate because it makes their goods ________ expensive abroad and foreign goods ________ in their countries.

more; cheaper

Everything else held constant, if a central bank makes a sterilized purchase of foreign assets, then the domestic currency will

not be affected.

Everything else held constant, if a central bank makes a sterilized sale of foreign assets, then the domestic currency will

not be affected.

A capital ________ can promote financial instability in an emerging-market country because it is what forces a country to ________ its currency.

outflow; devalue

Capital ________ are American purchases of foreign assets, and capital ________ are foreign purchases of American assets.

outflows; inflows

Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________ par, the central bank must intervene to purchase the domestic currency by selling foreign assets.

overvalued; below

Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central bank's attempt to keep its currency from depreciating will result in a ________ of international reserves.

overvalued; loss

When the domestic currency is initially overvalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

purchase; decline

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will increase and the domestic currency will ________.

purchase; depreciate

A central bank's attempt to prevent an appreciation of its currency can stimulate domestic inflation if the ________ of foreign currencies leads to ________ international reserves which ________ the monetary base.

purchase; higher; increases

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will ________ and the domestic currency will depreciate.

purchase; increase

A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal decline in its international reserves and the monetary base, everything else held constant.

purchase; sale

Under a fixed exchange rate regime, if a central bank must intervene to purchase the domestic currency by selling foreign assets, then, like an open market sale, this action ________ the monetary base and the money supply, causing the interest rate on domestic assets to ________.

reduces; rise

Under the Bretton Woods system, the United States was designated as the

reserve-currency country.

Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will decrease and the domestic currency will ________.

sale; appreciate

A central bank's attempt to prevent an appreciation of its currency can stimulate domestic inflation if the ________ of its currency leads to ________ international reserves which ________ the monetary base.

sale; higher; increases

A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal increase in its international reserves and the monetary base, everything else held constant.

sale; purchase

When the domestic currency is initially undervalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

sell; increase

A speculative attack involves massive sales of a ________ currency or purchases of a ________ currency that cause a sharp change in the exchange rate under a ________ exchange rate system.

weak; strong; fixed