Question

QUESTION 17. Suppose there is an increase in the foreign interest rate. A country that fixes its exchange rate   the Government instead uses a short‐term expansionary fiscal policy such as increasing government spending or cutting taxes) to improve the economy,  

A. Both the current account and output will increase in the short‐run.

B. The current account will worsen in the short run, and output will increase.

C. Output will increase, but there will be no effect on the current account, since exchange rates are fixed.

D. Output cannot increase, because if it does, domestic interest rates must rise and this is inconsistent with a

fixed exchange rate and the fact that home interest rates equal foreign rates under a fixed exchange rate.

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QUESTION 18. In early May 1971, Germany was forced to purchase several billion US dollars to maintain the value of the

dollar in terms of the mark.  Eventually, the Bundesbank floated the mark.  An explanation for this sudden change of

events, as well as the ultimate policy taken by the German central bank is:

   

A.   People expected that the Bundesbank would not be able to defend the fixed dollar-mark rate and this drove the expected nominal return (expressed in dollars) of mark denominated assets up.  The Bundesbank

was then forced with 2 options ‐ increase the money supply or let the mark float.

   

B.   People expected that the Bundesbank would not be able to defend the fixed dollar‐mark rate, and this drove down the expected nominal return (expressed in dollars) of mark denominated assets. The Bundesbank was then forced with 2 options ‐sell off dollars and decrease the money supply or let the mark float.

   

C.   People anticipated that Nixon was about to impose wage‐and‐price controls. This led them to want to

acquire marks in order now in order to convert to dollars in the future and be able to purchase US goods at

much lower prices.

   

D.   People anticipated that Nixon was about to impose wage‐and price controls. This would have led to a sizable real depreciation of the German real exchange rate, and German Goods would have been then cheaper. Seeing this, individuals wanted to acquire marks. The Bundesbank was then forced with 2 options - increase the money supply or let the mark float.

  

E.    None of the above.

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QUESTION 19. Under the Bretton Woods system, some countries experienced problems with external imbalance (large current account deficits) and internal imbalance (large scale unemployment, i.e., levels of output below the potential full-employment GDP as well as government budget deficits). All these problems could be alleviated in the short-run by

A.    An expansionary fiscal policy (cut in taxes/increase in government spending)

B.    An expansionary monetary policy (increasing in the money supply).

C.   A combination of A and B.

D.  A tighter fiscal policy (reduction in government spending/increase in taxes) and an expansionary monetary policy.

E.   To tackle these problems in the short-run required a devaluation of the home currency, which was meant to be infrequent under Bretton Woods.

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QUESTION 20.  In the early 1930's, the U.S. imposed tariffs on a number of imports to the U.S. (the

Smoot‐Hawley tariff).  At this time, the U.S. dollar was fixed to gold.  In theory, the tariff should:

A.  Have no effect on the U.S. current account, since the exchange rate is fixed under a gold standard, so there will be

no change in the real exchange rate.

B.  Increase U.S. output, since the tariff makes foreign goods more expensive in the U.S. . The U.S. current account

improves, but the U.S. loses gold in the process of fixing the price of gold in terms of the dollar.

C  Lead to an increase in the U.S. current account, since the tariff makes foreign goods more expensive in the US.  

The improvement in the current account raises income in the U.S. . The Federal Reserve gains gold reserves,

as the U.S. must increase the U.S. money supply as it buys gold in order to prevent a decrease in the gold price.

D. Will worsen the U.S. output and the current account, since the U.S. will need to buy gold in order to prevent the

real exchange rate (the value of foreign goods in terms of U.S. goods) from increasing once the tariff is in place.

E.  Force the U.S. off the gold standard, since the tariff will cause U.S. aggregate expenditures and income to increase.  

This will raise interest rates in the U.S. and the value of foreign currencies in terms of the dollar must fall (the dollar

must appreciate) as trades acquire U.S. dollar denominated assets.

Answer 1

17 d) Output cannot increase, because if it does, domestic interest rates must rise and this is inconsistent with a fixed exchange rate and the fact that home interest rates equal foreign rates under a fixed exchange rate.

18. c)  People anticipated that Nixon was about to impose wage‐and‐price controls. This led them to want toacquire marks in order now in order to convert to dollars in the future and be able to purchase US goods at much lower prices.

19.c) Acomination of Both A and B

20.b) Increase U.S. output, since the tariff makes foreign goods more expensive in the U.S. . The U.S. current account