ECN 162 Final

SCENARIO: ARUBAN FLORIN Aruba pegs its currency (the Aruban florin) to the U.S. dollar at a rate of Af 1.79 = $US1. (Scenario: Aruban florin) Suppose that Aruba's money supply is Af 20 billion and Aruba's central bank holds $10 billion of dollar reserves and Af 2.10 billion of domestic bonds. What is the backing ratio for Aruban florins?

89.5%

Use the following to answer questions 46-50. SCENARIO: ARUBAN FLORIN Aruba pegs its currency (the Aruban florin) to the U.S. dollar at a rate of Af 1.79 = $US1. Suppose that the actual exchange rate is equal to this pegged rate. 46. (Scenario: Aruban florin) Now suppose that the Aruban central bank buys dollars, keeping domestic credit fixed. Which of the following describes the effect of this dollar purchase on Aruba's exchange rate?

????

Which of the following occurs during a default crisis?

A government is unable to pay principal or interest on debt owed to banks

Why might a default crisis be associated with an exchange rate crisis?

A large depreciation causes a sudden increase in the local currency value of international debts denominated in other currencies

Which of the following occurs during a banking crisis?

Banks close or declare bankruptcy

Which statement is correct?

Exchange rate crises typically impose larger relative costs on emerging-market countries than on advanced countries

A cost-benefit analysis can be done to assess whether a nation should fix or float. Which of the following is not correct?

If the net benefits of a fixed exchange rate are positive, economically speaking the nation should float

SCENARIO: ARUBAN FLORIN Aruba pegs its currency (the Aruban florin) to the U.S. dollar at a rate of Af 1.79 = $US1. Suppose that the actual exchange rate is equal to this pegged rate. (Scenario: Aruban florin) Which of the following best describes the effect on Aruba's interest rates from purchasing dollar reserves, keeping domestic credit and price level fixed?

Interest rates will fall

SCENARIO: ARUBAN FLORIN Aruba pegs its currency (the Aruban florin) to the U.S. dollar at a rate of Af 1.79 = $US1. (Scenario: Aruban florin) Suppose that Aruba's money supply is Af 20 billion and Aruba's central bank holds $10 billion of dollar reserves (be mindful of the exchange rate!) and Af 2.10 billion of domestic bonds. What will happen to Aruba's backing ratio if its central bank sells $5 billion of U.S. dollars to Aruban citizens?

It will fall to 81%

Which of the following methods would the central bank not use to keep the exchange value of its currency fixed?

It would ensure that the domestic money supply increased to maintain PPP

Which method would the central bank not use to keep the exchange value of its currency fixed?

It would ensure that the domestic money supply increased to maintain uncovered interest and PPP

Suppose that Mexico and Canada both peg their currencies to the U.S. dollar. Now suppose that the U.S. dollar depreciates by 50% against the euro, the pound, and the yen. Which country (Canada or Mexico) will find it more difficult to maintain its peg against the U.S. dollar?

Neither Canada nor Mexico will find it difficult to maintain their pegs against the U.S. dollar

Which statement below is correct?

The likelihood of an exchange rate crisis increases if a country is having a banking crisis

What is the most powerful argument against a fixed exchange rate?

The nation gives up its ability to control its money supply and affect its own interest rates

If a nation's interest rate on foreign currency deposits is higher inside than outside the nation, it is a result of:

a country premium, meaning investors are concerned about defaults or capital controls

Typically an exchange rate crisis can be caused by:

a government default on debt and a banking crisis, triggered by adverse shocks

One economic cost of an exchange rate crisis is:

a slowing in a country's rate of economic growth

With a flexible exchange rate system, to gain credibility with investors or savers, a nation will often:

adopt a nominal anchor to keep currency growth in line with a measurable indicator such as exchange rates or inflation rates

If domestic credit is constant, then any change in the demand for money will result in:

an equal change in foreign currency reserves

A banking crisis often threatens a fixed exchange rate (or peg). Why?

because the central bank may have to bail out insolvent banks by inflating the currency, which could cause a loss of reserves

Symmetric shocks pose fewer problems for nations linked by fixed exchange rates to a base currency. In general:

because there are common problems, the economic policy taken by the base currency nation is beneficial for both nations

When a nation chooses to fix or float, it should consider:

both the level of economic integration and the similarity of demand or supply shocks

To maintain the peg, a nation must keep its money supply constant, which it does by:

buying and selling foreign reserves and domestic assets for its own currency

When other emerging market nations experience exchange rate crises, there is an effect on healthy emerging market economies (increase in risk premia) because of investor worry. This phenomenon is known as:

contagion

When a nation is economically integrated with trading partners, fixed exchange rates:

could promote integration and economic efficiency by keeping transaction costs low

Twelve European countries use the euro as their common currency. This arrangement is best described as a:

currency union

Suppose that country A pegs its currency to the currency of country B. Which of the following will not be a benefit of this arrangement to country A?

decreased migration between the two countries because of increased certainty of future exchange rates

When a fixed exchange rate system is adopted, it results in all of the following except:

decreased volume of trade

When a nation is maintaining an exchange rate peg, typically its money supply is backed by:

domestic bonds and foreign exchange assets purchased with the national currency

Which of the following is counted in the domestic assets of a central bank?

domestic bonds that it purchases with money that it issues

In a fixed exchange rate system, the center country, to whose currency the other countries peg their exchange rate, will:

easily implement monetary and fiscal policy to suit its own economy

A fixed exchange rate causes:

efficiency to increase only if the economies are integrated

Lower transaction costs are a benefit of fixed exchange rates. Therefore, relative prices in two trading nations linked by fixed exchange rates should:

experience more price convergence

If the central bank holds no foreign currency reserves, the nation's exchange rate is:

floating

In nations that cannot borrow in their own currencies, which exchange rate system is more destabilizing and less useful in terms of stabilizing GDP?

floating exchange rates

A ratio indicating how safe the peg is from breaking is calculated by _______ and is called ________.

foreign reserves as a percent of the total money supply; the backing ratio

If there is a greater degree of economic similarity between the home nation and the base currency nation, the economic stabilization benefit of pegged exchange rates:

gets larger

Economic integration refers to the growth of market linkages in:

goods, capital and labor

Uncovered interest parity may actually result in domestic interest rates being ____ than foreign rates because of investors' perceived risk of holding assets based in the domestic currency.

higher

Which of the following events is least likely to take place under a fixed exchange rate system?

increase in cost of trade because of higher transaction costs

When maintaining a peg, if the central bank runs out of foreign currency reserves, then:

it must allow the domestic currency to float

When a country adopts a currency board system:

its reserves equal 100% of its money supply

To maintain a fixed exchange rate, a nation's central bank must:

keep the level of foreign reserves above zero so that it can prevent a fall in value of its currency

All other things being equal, we expect fixed exchange rates to promote trade by lowering transactions costs. If that is true, then differences in prices measured in a common currency should be ________among countries with ______exchange rates than among countries with ______ rates.

lower; fixed; floating

SCENARIO: ARUBAN FLORIN Aruba pegs its currency (the Aruban florin) to the U.S. dollar at a rate of Af 1.79 = $US1. Suppose that the actual exchange rate is equal to this pegged rate. (Scenario: Aruban florin) Which of the following best describes the effect on Aruba's money supply from purchasing dollars, keeping domestic credit fixed?

money supply will increase

If the central bank desires to purchase additional domestic bonds to stimulate the economy, then to maintain the peg and ensure that the exchange rate does not change, it must:

sell enough reserves to keep the interest rate unchanged

When the central bank engages in sterilization of reserves, it is:

selling reserves to offset the purchase of government bonds

Changes in the domestic money supply are a result of:

some combination of changes in the central bank's holdings of domestic credit or foreign reserves

The reason for the concurrence of exchange rate crises and other financial disruptions centers around:

the fact that changes in exchange rates can raise debt burdens (denominated in other currencies) to intolerable levels

The risk premium is the difference between foreign and domestic rates of interest under parity. This premium has three distinct parts. Which is not a factor in the risk premium?

the floating risk premium

If there is a greater degree of economic integration between markets in the home country and the base country:

the home country will benefit to a greater degree by fixing its exchange rate with the base country

The difference between asymmetric and symmetric shocks is that:

the latter results in identical policies being implemented.

When exchange rates are volatile:

trade and cross-border financial and labor flows are reduced as uncertainty and transaction costs take their toll

Fear of floating is:

when the attractions of fixed exchange rates are large relative to those of floating

Asymmetric shocks pose a problem for nations linked by fixed exchange rates to a base currency. In general:

when the base currency nation takes any action to counteract the shock, it forces its exchange rate partner to do the same to maintain its peg.