FIN 4550 Chapter 2 Quiz
Currencies
monies issued by national monetary authorities
List the conditions that have been identified as warning signs leading up to a currency crisis.
The following conditions have been identified as warning signs in the period leading up to a currency crisis: • Terms of trade (i.e., ratio of exports to imports) deteriorate. • Fixed or partially fixed exchange rates (versus floating exchange rates). • Official foreign exchange reserves dramatically decline. • Currency value that has risen above its historical mean. • Inflation increases. • Liberalized capital markets that allow for the free flow of capital. • Money supply relative to bank reserves increases. • Banking crises (may also be coincident).
International Monetary System
The institutional framework within which international payments are made, movements of capital are accommodated, and exchange rates among currencies are determined
Free Floating Exchange Rate
A floating exchange rate can be classified as free floating if intervention occurs only exceptionally and aims to address disorderly market conditions and if the authorities have provided information or data confirming that intervention has been limited to at most three instances in the previous six months, each lasting no more than three business days
Floating Exchange Rate
A floating exchange rate is largely market determined, without an ascertainable or predictable path for the rate
Discuss the criteria for a "good" international monetary system
A good international monetary system should provide (i) sufficient liquidity to the world economy, (ii) smooth adjustments to BOP disequilibrium as it arises, and (iii) safeguard against the crisis of confidence in the system.
Monetary policy
Actions taken by a nation's central bank to affect aggregate output and prices through changes in bank reserves, reserve requirements, or its target interest rates
Central Bank
Banker to the government, to other banks, and the supplier of the nation's currency
Rebut the above criticism from the standpoint of the proponents of the flexible exchange rate regime.
Economic agents can hedge exchange risk by means of forward contracts and other techniques. They don't have to bear it if they choose not to. In addition, under a fixed exchange rate regime, governments often restrict international trade in order to maintain the exchange rate. This is a self-defeating measure. What's good about having the fixed exchange rate if international trade need to be restricted?
Criticize the flexible exchange rate regime from the viewpoint of the proponents of the fixed exchange rate regime.
If exchange rates are fluctuating randomly, that may discourage international trade and encourage market segmentation. This, in turn, may lead to suboptimal allocation of resources.
Why were international trade organizations created? Briefly describe the goals of each organization: World Bank, International Monetary Fund, and World Trade Organization.
International trade organizations were created to encourage international trade and development. • World Bank: mission is to end extreme poverty and to promote shared prosperity. • IMF: Ensuring stability of the exchange rate system and stability of the international payments system. • WTO: The goal is to ensure that trade flows as smoothly, predictably and freely as possible.
Once capital markets are integrated, it is difficult for a country to maintain a fixed exchange rate. Explain why this may be so.
Once capital markets are integrated internationally, vast amounts of money may flow in and out of a country in a short time period. This will make it very difficult for the country to maintain a fixed exchange rate.
Explain how special drawing rights (SDRs) are constructed. Also, discuss the circumstances under which the SDRs were created.
SDR was created by the IMF in 1970 as a new reserve asset, partially to alleviate the pressure on the U.S. dollar as the key reserve currency. The SDR is a basket currency currently comprised of five major currencies, i.e., the U.S. dollar, euro, Chinese yuan, Japanese yen, and British pound. Currently, the dollar receives a 41.73% weight, euro 30.93%, yuan 10.92, yen 8.33%, and pound 8.09%. The weights for different currencies tend to change over time, reflecting the relative importance of each currency in international trade and finance.
G-7
The G7 serves as a forum for highly industrialized democracies to coordinate economic, security, and energy policy, but the new U.S. administration has stirred questions about the group's cohesion and relevance to global governance. The G7 countries include: Canada, France, Japan, Germany, Italy, United Kingdom, United States.
List the advantages of the flexible exchange rate regime.
The advantages of the flexible exchange rate system include: (i) automatic achievement of balance of payments equilibrium and (ii) maintenance of national policy autonomy.
Fiscal Policy
The use of taxes and government spending to affect the level of aggregate expenditures
