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1. ECO 305 Week 11 Quiz – Strayer
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Quiz 10 Chapter 16 and 17
MACROECONOMIC POLICY IN AN OPEN ECONOMY
MULTIPLE CHOICE
1. A nation experiences internal balance if it achieves:
a. Full employment
b. Price stability
c. Full employment and price stability
d. Unemployment and price instability
2. A nation experiences external balance if it achieves:
a. No net changes in its international gold stocks
b. Productivity levels equal to those of its trading partners
c. An increase in its money supply equal to increases overseas
d. Equilibrium in its balance of payments
3. A nation experiences overall balance if it achieves:
a. Balance-of-payments equilibrium, full employment, and price stability
b. Balance-of-payments equilibrium, maximum productivity, and price stability
c. Full employment, price stability and no change in its money supply
d. Full employment, price stability, and maximum productivity
4. Most industrial countries generally considered ____ as the most
important economic goal.
a. External balance
b. Internal balance
c. Maximum efficiency for business
d. Maximum efficiency for labor
5. Which policies are expenditure-changing policies?

2. a. Currency devaluation and revaluation
b. Import quotas and tariffs
c. Monetary and fiscal policy
d. Wage and price controls
6. Which policy is an expenditure-switching policy?
a. Increase in the money supply
b. Decrease in government expenditures
c. Increase in business and household taxes
d. Decrease in import tariffs
7. An expenditure-increasing policy would consist of an increase in:
a. Import tariffs
b. Import quotas
c. Governmental taxes
d. The money supply
8. An expenditure-reducing policy would consist of a decrease in:
a. The par value of a currency
b. Government expenditures
c. Import duties
d. Business or household taxes
9. Given fixed exchange rates, assume Mexico initiates expansionary
monetary and fiscal policies to combat recession. These policies will also:
a. Increase both imports and exports
b. Increase exports and reduce imports
c. Reduce a balance-of-payments surplus
d. Reduce a balance-of-payments deficit
10. Given fixed exchange rates, assume Mexico initiates contractionary
monetary and fiscal policies to combat inflation. These policies will also:
a. Reduce a balance-of-payments surplus
b. Reduce a balance-of-payments deficit
c. Increases both imports and exports

3. d. Decrease both imports and exports
11. The appropriate expenditure-switching policy to correct a current
account surplus is:
a. Currency revaluation
b. Currency devaluation
c. Expansionary monetary policy
d. Contractionary fiscal policy
12. The appropriate expenditure-switching policy to correct a current
account deficit is:
a. Contractionary monetary policy
b. Expansionary fiscal policy
c. Currency devaluation
d. Currency revaluation
13. Suppose the United States faces domestic recession and a current
account deficit. Should the United States devalue the dollar, one would expect the:
a. Recession to become less severe--deficit to become less severe
b. Recession to become more severe--deficit to become less severe
c. Recession to become less severe--deficit to become more severe
d. Recession to become more severe--deficit to become more severe
14. Suppose the United States faces domestic inflation and a current
account surplus. Should the United States revalue the dollar, one would expect the:
a. Inflation to become more severe--surplus to become less severe
b. Inflation to become less severe--surplus to become less severe
c. Inflation to become less severe--surplus to become more severe
d. Inflation to become more severe--surplus to become more severe
15. Suppose Brazil faces domestic recession and a current account surplus.
Should Brazil revalue its currency, one would expect the:
a. Recession to become less severe--surplus to become less severe
b. Recession to become more severe--surplus to become more severe
c. Recession to become more severe--surplus to become less severe

4. d. Recession to become less severe--surplus to become more severe
16. Suppose that Brazil faces domestic inflation and a current account
deficit. Should Brazil devalue its currency, one would expect the:
a. Inflation to become more severe--deficit to become less severe
b. Inflation to become more severe--deficit to become more severe
c. Inflation to become less severe--deficit to become less severe
d. Inflation to become less severe--deficit to become more severe
17. In a closed economy, which of the following will cause the economy's
aggregate demand curve to shift to the right?
a. decreases and wages and salaries paid to employees
b. increases in the prices of oil and natural gas
c. decreases in income taxes for households
d. decreases in the productivity of labor
18. Given an open economy with high capital mobility and floating
exchange rates, suppose an expansionary monetary policy is implemented to combat
recession. The initial and secondary effects of the policy
a. cause aggregate demand to increase, thus strengthening the policy's
expansionary effect on real output
b. cause aggregate demand to decrease, thus eliminating the policy's
expansionary effect on real output
c. have conflicting effects on aggregate demand, thus weakening the policy's
expansionary effect on real output
d. have conflicting effects on aggregate demand, thus strengthening the policy's
expansionary effect on real output
19. A problem that economic policy makers confront when attempting to
promote both internal and external balance for the nation is that monetary or fiscal
policies aimed at the domestic sector also have impacts on:
a. Trade flows only
b. Capital flows only
c. both trade flows and capital flows
d. Neither trade flows nor capital flows

5. 20. Given an open economy with high capital mobility and floating
exchange rates, suppose an expansionary fiscal policy is implemented to combat
recession. The initial and secondary effects of the policy
a. cause aggregate demand to increase, thus strengthening the policy's
expansionary effect on real output
b. cause aggregate demand to decrease, thus eliminating the policy's
expansionary effect on real output
c. have conflicting effects on aggregate demand, thus weakening the policy's
expansionary effect on real output
d. have conflicting effects on aggregate demand, thus strengthening the policy's
expansionary effect on real output
21. A system of fixed exchange rates and high capital mobility strengthens
which policy in combating a recession:
a. Expansionary fiscal policy
b. Expansionary monetary policy
c. Contractionary fiscal policy
d. Contractionary monetary policy
22. A system of floating exchange rates and high capital mobility
strengthens which policy in combating a recession:
a. Expansionary fiscal policy
b. Expansionary monetary policy
c. Contractionary fiscal policy
d. Contractionary monetary policy
23. Given an open economy with high capital mobility, all of the following
statements are true except:
a. fiscal policy is strengthened under fixed exchange rates
b. monetary policy is weakened under fixed exchange rates
c. monetary policy is strengthened under floating exchange rates
d. fiscal policy is strengthened under floating exchange rates
24. Under a system of managed-floating exchange rates with heavy
exchange rate intervention:
a. Fiscal policy is successful in promoting internal balance, while monetary
policy is unsuccessful

6. b. Monetary policy is successful in promoting internal balance, while fiscal
policy is unsuccessful
c. Both fiscal policy and monetary policy are successful in promoting internal
balance
d. Neither fiscal policy nor monetary policy are successful in promoting internal
balance
25. Given a system of floating exchange rates, an expansionary monetary
policy by the Federal Reserve will cause
a. the dollar to appreciate and will decrease U.S. net exports
b. the dollar to appreciate and will increase U.S. net exports
c. the dollar to depreciate and will increase U.S. net exports
d. the dollar to depreciate and will decrease U.S. net exports
26. Given a system of floating exchange rates, a contractionary monetary
policy by the Federal Reserve will cause
a. the dollar to appreciate and will decrease U.S. net exports
b. the dollar to appreciate and will increase U.S. net exports
c. the dollar to depreciate and will increase U.S. net exports
d. the dollar to depreciate and will decrease U.S. net exports
27. All of the following are obstacles to international economic policy
coordination except:
a. Different national objectives and institutions
b. Different national political climates
c. Different phases in the business cycle
d. Different national currencies
28. Suppose a central bank prevents a depreciation of its currency by
intervening in the foreign exchange market and buying its currency with foreign
currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a rise in aggregate demand

7. 29. At the ____, the Group-of-Five nations agreed to intervene in the
currency markets to promote a depreciation in the U.S. dollar's exchange value.
a. Plaza Agreement of 1985
b. Louvre Accord of 1987
c. Bonn Summit of 1978
d. Tokyo Summit of 1962
30. The Plaza Agreement of 1985 and Louvre Accord of 1987 are
examples of:
a. Tariff trade barrier formation
b. Nontariff trade barrier formation
c. International economic policy coordination
d. Beggar-thy-neighbor policies
Exhibit 16.1
At the Plaza Accord of 1985, the Group-of-Five nations agreed to drive the value of
the dollar downward (i.e., depreciation) so as to help reduce the U.S. trade deficit.
Answer the following question(s) on the basis of this information.
31. Refer to Exhibit 16.1. To help drive the dollar's exchange value
downward, the Federal Reserve would:
a. Reduce taxes
b. Increase taxes
c. Decrease the money supply
d. Increase the money supply
32. Refer to Exhibit 16.1. The Federal Reserve might refuse to support the
accord on the grounds that when helping to drive the dollar's exchange value
downward, it promotes an increase in the U.S.:
a. Rate of inflation
b. Budget deficit
c. Unemployment level
d. Economic growth rate
33. Under a fixed exchange-rate system and high capital mobility, an
expansion in the domestic money supply leads to:

8. a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit
34. Under a fixed exchange-rate system and high capital mobility, a
contraction in the domestic money supply leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit
35. Under a fixed exchange-rate system and high capital mobility, an
expansionary fiscal policy leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit
36. Under a fixed exchange-rate system and high capital mobility, a
contractionary fiscal policy leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit
37. Suppose a central bank prevents a depreciation of its currency by
intervening in the foreign exchange market and buying its currency with foreign
currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a fall in aggregate demand

9. 38. Suppose a central bank prevents an appreciation of its currency by
intervening in the foreign exchange market and selling its currency for foreign
currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a fall in aggregate demand
39. Assume a system of floating exchange rates. In response to relatively
high interest rates abroad, suppose domestic investors place their funds in foreign
capital markets. The result would be
a. a depreciation of the domestic currency and a rise in net exports
b. a depreciation of the domestic currency and a fall in net exports
c. an appreciation of the domestic currency and a rise in net exports
d. an appreciation of the domestic currency and a fall in net exports
40. Assume a system of floating exchange rates. In response to relatively
high domestic interest rates, suppose that foreign investors place their funds in
domestic capital markets. The result would be
a. a depreciation of the domestic currency and a rise in net exports
b. a depreciation of the domestic currency and a fall in net exports
c. an appreciation of the domestic currency and a rise in net exports
d. an appreciation of the domestic currency and a fall in net exports
41. When a nation realizes external balance
a. it can have a current account deficit
b. it can have a current account surplus
c. it has neither a current account deficit nor a current account surplus
d. Both a and b
42. Direct controls may take the form of
a. Tariffs
b. Export subsidies
c. Export quotas
d. All of the above

10. 43. With a fixed exchange rate system, internal balance is most effectively
achieved by using
a. Expansionary monetary policy to combat recession
b. Expansionary fiscal policy to combat inflation
c. Contractionary monetary policy to combat recession
d. Contractionary fiscal policy to combat recession
44. Policy coordination is complicated by
a. Different economic objectives
b. Different national institutions
c. Different phases in the business cycle
d. All of the above
TRUE/FALSE
1. A nation realizes internal balance if economy achieves full
employment and price stability.
2. Nations have typically placed greater importance to the goal of internal
balance than to the goal of external balance.
3. A nation realizes external balance when its current account is in
equilibrium.
4. A nation realizes overall balance when it achieves full employment
and current account equilibrium.
5. Expenditure-changing policies modify the direction of aggregate
demand, shifting it between domestic output and imports.
6. Expenditure-switching policies include fiscal policy and monetary
policy.

11. 7. Economic policymakers have typically adopted expenditure-increasing
policies to combat inflation and expenditure-reducing policies to combat recession.
8. Expenditure-switching policies alter the level of total spending
(aggregate demand) for goods and services produced domestically and those
imported.
9. Currency devaluation and revaluation are considered to be
expenditure-changing policies since they alter a country's aggregate demand for goods
and services.
10. Expenditure-switching policies include currency revaluation, currency
devaluation, and direct controls such as tariffs, quotas, and subsidies.
11. Given an open economy with high capital mobility and floating
exchange rates, suppose an expansionary monetary policy is implemented to combat
recession. The initial and secondary effects of the policy have conflicting effects on
aggregate demand, thus weakening the policy's expansionary effect.
12. Given an open economy with high capital mobility and fixed exchange
rates, suppose an expansionary fiscal policy is implemented to combat recession. The
initial and secondary effects of the policy cause aggregate demand to increase, thus
strengthening the policy's expansionary effect.
13. When the economy is in deep recession or depression, it is operating
on that portion of its aggregate supply curve that is horizontal.
14. Changes in a country's net exports, investment spending, or
government spending will cause its aggregate demand curve to shift.
15. Given an open economy with high capital mobility, fiscal policy is
strengthened under fixed exchange rates.

12. 16. Given an open economy with high capital mobility, monetary policy is
strengthened under fixed exchange rates.
17. Under floating exchange rates and high capital mobility, an
expansionary monetary policy would help a country resolve a recession and a current
account deficit.
18. Exchange rate management policies require international policy
coordination because a depreciation of one nation's currency implies an appreciation
of its trading partner's currency.
19. Currency devaluation and revaluation primarily affect the economy's
current account and have secondary effects on domestic employment and inflation.
20. Fiscal and monetary policies are generally used to combat domestic
recession and inflation and have secondary effects on the balance of payments.
21. The Group of five (G-5) nations include Japan, Germany, China, and
Australia.
22. The Bonn Summit of 1978 and Plaza Accord of 1985 are examples of
international policy coordination.
23. International policy coordination is plagued by differing national
economic objectives, institutions, political climates, and phases in the business cycle.
24. The goals of the Plaza Agreement of 1985 were to combat
protectionism in the U.S. Congress, promote world economic expansion by
stimulating demand in Germany and Japan, and to ease the burden of the U.S. debt
service.

13. SHORT ANSWER
1. What policy instrument should be used when demand-pull inflation
exists?
2. What happens to the balance of payments under a fixed exchange rate
system, when expansionary or contractionary monetary policy is used?
ESSAY
1. Was the Plaza Agreement of 1985 a success?
2. What is international economic policy coordination?
CHAPTER 17—INTERNATIONAL BANKING: RESERVES, DEBT, AND
RISK
MULTIPLE CHOICE
1. Which of the following assets makes use of the basket valuation
technique?
a. Swap agreements
b. Oil facility
c. Buffer stock facility
d. Special drawing rights
2. Swap agreements are generally conducted by the:
a. Federal Reserve with foreign central banks
b. Federal Reserve with foreign commercial banks
c. U.S. Treasury with foreign central banks
d. U.S. Treasury with foreign commercial banks

14. 3. Which of the following is a main central bank function of the
International Monetary Fund?
a. The conduct of open market operations
b. The issuance of gold certificates
c. The provision of monetary policy for member nations
d. The granting of loans to member nations
4. The Federal Reserve's swap network represents:
a. Efforts to stabilize only the value of the dollar
b. Efforts to stabilize only the value of foreign currencies
c. Long-term borrowing among countries
d. Short-term borrowing among countries
5. International trade and investment are most frequently financed by the
U.S. dollar and the:
a. Japanese yen
b. British pound
c. Australian dollar
d. Swiss franc
6. The purpose of international reserves is to finance:
a. Short-term surpluses in the balance of payments
b. Long-term surpluses in the balance of payments
c. Short-term deficits in the balance of payments
d. Long-term deficits in the balance of payments
7. The currencies generally referred to as "reserve currencies" are the:
a. Japanese yen and U.S. dollar
b. Swiss franc and Japanese yen
c. British pound and U.S. dollar
d. Swiss franc and British pound
8. Which of the following does not represent a form of international
liquidity?
a. IMF reserve positions

15. b. General arrangements to borrow
c. U.S. government securities
d. Reciprocal currency arrangements
9. Which of the following is not considered an "owned" reserve?
a. National currencies
b. Gold
c. Special drawing rights
d. Oil facility
10. Which of the following is not considered a "borrowed" reserve?
a. Special drawing rights
b. Oil facility
c. IMF drawings
d. Reciprocal currency arrangement
11. Eurodollars are:
a. Dollar-denominated deposits in overseas banks
b. European currencies used to finance transactions in the United States
c. Dollars that U.S. residents spend in Europe
d. European currencies used to finance imports from the United States
12. Which of the following is not a characteristic of the Eurodollar
market? It:
a. Is mainly located in the United Kingdom and continental Europe
b. Operates as a financial intermediary, bringing together lenders and borrowers
c. Deals in interest-bearing time deposits and loans to governments
d. Grew in response to the deregulation of interest rate ceilings on U.S. savings
accounts
13. Which of the following assets was (were) created in 1970 to provide
additional international liquidity, in the belief that increasing world trade requires
more liquidity for larger expected payments imbalances?
a. Eurodollar market
b. Special drawing rights

16. c. Reciprocal currency arrangements
d. General arrangements to borrow
14. Which of the following constitute(s) the largest component of the
world's international reserves?
a. Gold
b. Special drawing rights
c. IMF drawings
d. Foreign currencies
15. With an international gold standard, if a country ended up with a
deficit from the balances on its current and capital accounts, it would:
a. Import gold to settle the balance
b. Export gold to settle the balance
c. Officially decrease the price of gold
d. Officially increase the price of gold
16. Which of the following is not a condition of the international gold
standard? That a nation must:
a. Convert gold into paper currency, and vice versa, at a stipulated rate
b. Permit gold to be freely imported and exported
c. Tolerate wide fluctuations in its exchange rate
d. Define its monetary unit in terms of a stipulated amount of gold
17. All of the following exchange-rate systems require international
reserves to finance balance-of-payments disequilibriums except:
a. Pegged or fixed exchange rates
b. Managed floating exchange rates
c. Adjustable pegged exchange rates
d. Freely floating exchange rates
18. A dollar shortage would indicate that the dollar is:
a. Undervalued in international markets
b. Overvalued in international markets
c. Overvalued in terms of gold

17. d. Overvalued in terms of special drawing rights
19. The U.S. gold outflow that began in the late 1940s and continued
through the 1960s was due in part to:
a. Crawling pegged exchange rates
b. Freely floating exchange rates
c. An undervalued dollar
d. An overvalued dollar
20. The U.S. dollar glut of the 1960s was due in part to:
a. An undervalued dollar
b. An overvalued dollar
c. Freely floating exchange rates
d. Crawling pegged exchange rates
21. For developing countries such as Mexico and Brazil, severe economic
problems in the 1980s were caused by:
a. A fall in the world demand for products produced by developing countries
b. High prices of basic raw materials and other commodities
c. Low real interest rates in the United States
d. High levels of income and imports for the United States
22. In response to the international debt problem, the United States set up a
special fund in 1986 to help make up for lost oil revenues. Under the plan, the United
States would make more money available as world oil prices fell. This plan was
designed to help:
a. Argentina
b. Saudi Arabia
c. Mexico
d. Brazil
23. Which indicator of international debt burden schedules interest and
principal payments on long-term debt as a percent of export earnings?
a. Debt service ratio
b. Debt-to-export ratio

18. c. Ratio of external debt to gross domestic product
d. Ratio of external debt to gross national product
24. Which term best describes the process in which the International
Monetary Fund provides loans to countries facing balance-of-payments difficulties
provided that they initiate programs holding promise of correcting these difficulties?
a. Conditionality
b. Debt service
c. Reciprocal currency arrangement
d. Swap agreement
25. All of the following are major goals of the International Monetary
Fund except:
a. Promoting international cooperation among member countries
b. Fostering a multilateral system of international payments
c. Making long-term development and reconstruction loans
d. Promoting exchange-rate stability and the elimination of exchange restrictions
26. Which international reserve asset was officially phased out of the
international monetary system by the United States in the early 1970s?
a. Special drawing rights
b. Swap agreements
c. General arrangements to borrow
d. Gold
27. Bilateral agreements between central banks, which provide for an
exchange of currencies to help finance temporary balance-of-payments
disequilibriums, are referred to as:
a. IMF drawings
b. Special drawing rights
c. Buffer stock facility
d. Swap agreements
28. Which organization is largely intended to make long-term
reconstruction loans to developing nations?

19. a. Export-Import Bank
b. World Bank
c. International Monetary Fund
d. United Nations
29. "Owned" international reserves consist of:
a. Special drawing rights
b. Oil facility
c. IMF drawings
d. Reciprocal currency arrangements
30. "Borrowed" international reserves consist of:
a. IMF drawings
b. Foreign currencies
c. Gold
d. Special drawing rights
31. Concerning international lending risk of commercial banks, ____
refers to the probability that part/all of the interest/principal of a loan will not be
repaid.
a. Country risk
b. Credit risk
c. Currency risk
d. Presidential risk
32. Concerning international lending risk of commercial banks, ____ is
closely related to political developments in a borrowing country, especially the
government's views concerning international investments and loans.
a. Economic risk
b. Credit risk
c. Country risk
d. Currency risk
33. Concerning international lending risk of commercial banks, ____ is
associated with possible changes in the exchange value of a nation's currency.

20. a. Political risk
b. Country risk
c. Credit risk
d. Currency risk
34. To reduce their exposure to developing country debt, lending
commercial banks have practiced all of the following except:
a. Making outright loan sales to other commercial banks
b. Reducing their capital base as a cushion against losses
c. Dealing in debt-for-debt swaps with foreign governments
d. Dealing in debt/equity swaps with foreign governments
35. To reduce losses on developing country loans, commercial banks
sometimes sell their loans, at a discount, to a developing country government for local
currency which is then used to finance purchases of ownership shares in developing
country industries. This practice is known as:
a. Debt forgiveness
b. Debt buyback
c. Debt-for-debt swap
d. Debt/equity swap
36. Concerning international debt, ____ refers to a negotiated reduction in
the contractual obligations of the debtor country and includes schemes such as
markdowns and write-offs of debt.
a. Debt/equity swap
b. Debt-for-debt swap
c. Debt forgiveness
d. Debt sales
37. The exchange of borrowing country debt for an ownership position in
the borrowing country is known as:
a. Debt forgiveness
b. Debt-for-debt swap
c. Debt reduction
d. Debt/equity swap

21. 38. "Country risk" analysis is concerned with all of the following except:
a. Depreciation of the borrowing country's currency
b. Political instability in the borrowing country
c. Economic growth in the borrowing country
d. External debt of the borrowing country
39. Debt reduction
a. Refers to any voluntary scheme that lessens the burden on the debtor nation
b. May be accomplished through debt rescheduling
c. May be achieved through debt/equity swaps
d. All of the above
40. Most analysts feel that the financial difficulties in East Asia were
triggered by
a. Misallocation of investment
b. Unavailability of cheap foreign labor
c. Lack of alignment of the exchange rate with the dollar
d. Surpluses in the trade accounts of the Asian countries
41. A nation may experience debt-servicing problems because of
a. Pursuit of improper macroeconomic policies
b. Inadequate borrowing
c. Adverse economic events
d. Both a and c
42. Swap arrangements
a. Are agreements between governments
b. Require repayment within a stipulated period
c. Are usually multilateral agreements
d. Are never initiated by telephone
TRUE/FALSE

22. 1. Under a system of fixed exchange rates, international reserves are
needed to bridge the gap between monetary receipts and monetary payments.
2. International reserves allow a country to finance disequilibria in its
balance-of-payments position.
3. An advantage of international reserves is that they allow countries to
sustain temporary balance-of-payments deficits until acceptable adjustment measures
can operate to correct the disequilibrium.
4. With floating exchange rates, countries require sizable amounts of
international reserves for the stabilization of exchange rates.
5. When exchange rates are fixed by central bankers, the need for
international reserves disappears.
6. When exchange rates are fixed by central bankers, international
reserves are necessary for financing payments imbalances and the stabilization of
exchange rates.
7. There exists a direct relationship between the degree of exchange rate
flexibility and the need for international reserves.
8. With floating exchange rates, payments imbalances tend to be
corrected by market-induced fluctuations in the exchange rate, and the need for
exchange-rate stabilization and international reserves disappears.
The diagram below represents the exchange market position of the United States in
trade with the United Kingdom. Starting at the equilibrium exchange rate of $3 per
pound, suppose the demand for pounds rises from D0 to D1.
Figure 17.1 Foreign Exchange Market

23. 9. Refer to Figure 17.1. Under a fixed exchange rate system, U.S.
monetary authorities would have to supply 8 million pounds in exchange for dollars to
keep the exchange rate at $3 per pound.
10. Refer to Figure 17.1. If the exchange rate was allowed to rise to $4 per
pound, U.S. monetary authorities would have to supply 6 million pounds to the
foreign exchange market in exchange for dollars to maintain this rate.
11. Refer to Figure 17.1. Under a floating exchange rate system, the
exchange rate would rise to $4 and U.S. monetary authorities would have to supply 4
million pounds to the foreign exchange market in exchange for dollars to maintain
this rate.
12. To the extent that adjustments in prices, interest rates, and income
levels promote balance-of-payments equilibrium, the demand for international
reserves decreases.
13. The greater a nation's propensity to apply tariffs and quotas to key
sectors, the greater will be the need for international reserves.
14. The demand for international reserves is negatively related to the level
of world prices and income.
15. The demand for international reserves tend to increase with the level of
world income and trade activity.
16. If a nation with a balance-of-payments deficit is willing and able to
initiate quick actions to increase export receipts and decrease import payments, the
amount of international reserves needed will be relatively large.
17. The supply of international reserves consists of owned reserves and
borrowed reserves.

24. 18. Foreign currencies constitute the smallest component of the world's
international reserves.
19. Gold constitutes the largest component of the world's international
reserves.
20. The U.S. dollar has been considered a reserve (key) currency because
trading nations have been willing to hold it as an international reserve asset.
21. The U.S. dollar, Japanese yen, British pound, and Mexican peso are
the major reserve currencies of the international monetary system.
22. By the 1990s, the British pound had replaced the U.S. dollar as the
world's key currency.
23. A goal of the International Monetary Fund is to make short-term loans
to member nations so as to allow them to correct balance of payments disequilibriums
without resorting to measures that would destroy national prosperity.
24. When granting loans to financially troubled nations, the International
Monetary Fund requires some degree of conditionality, meaning that the borrowing
nation must agree to implement economic policies as mandated by the IMF.
25. The International Monetary Fund has sometimes demanded that
financially-troubled nations, that borrow from the IMF, undergo austerity programs
including slashing of public spending and private consumption.
26. The main purpose of the International Monetary Fund is to grant long-
term loans to developing nations to help them finance the development of
infrastructure such as roads, dams, and bridges.

25. 27. Gold is currently the most widely used asset in the international
monetary system.
28. In 1974 the United States revoked a 41-year ban on U.S. citizen's
ownership of gold.
29. In 1975 the official price of gold was abolished as the unit of account
for the international monetary system. As a result, gold was demonetized as an
international reserve asset.
30. In the 1970s, the major industrial countries abandoned the managed-
floating exchange rate system and adopted a system of fixed exchange rates tied to the
price of gold.
31. Created by the International Monetary Fund, special drawing rights
(SDRs) are unconditional rights to draw currencies of other nations, thus enabling
countries to finance their current-account deficits.
32. The value of the SDR is tied to a currency basket consisting of the U.S.
dollar, German mark, Japanese yen, French franc, and British pound.
33. The SDR has replaced the dollar, yen, and mark as the key asset of the
international financial system.
34. Because the value of the SDR is tied directly to the value of the U.S.
dollar, a 10 percent dollar depreciation would result in a 10 percent decrease in the
SDR's value.
35. A main purpose of the International Monetary Fund is to make loans of
foreign currencies to member countries which are experiencing current-account
surpluses.

26. 36. When a deficit nation borrows from the International Monetary Fund,
it purchases with its currency the foreign currency required to help finance the
payments deficit.
37. The so-called General Arrangements to Borrow provide a permanent
increase in the supply of international reserves.
38. Swap arrangements are bilateral agreements between central banks to
allow countries to temporarily borrow funds to ease current-account deficits and
discourage speculative capital flows.
39. IMF drawings, swap arrangements, buffer stock facility, and
compensatory financing for exports are classified as owned reserves rather than
borrowed reserves.
40. Concerning international lending risk, credit risk refers to the
probability that part or all of the interest rate or principal of a loan will not be repaid.
41. Concerning international lending risk, country risk refers to the risk
that part or all of the interest or principal of a loan will not be repaid.
42. Concerning international lending risk, currency risk is the risk of asset
losses due to changing currency values.
43. A country with a high debt/export ratio and a high debt service/export
ratio would likely be considered as an attractive place in which to invest by foreign
residents.
44. A debt buyback is a debt-reduction technique in which a government
of a debtor nation buys loans from commercial banks at a discount.

27. 45. Under a debt-for-debt swap, a commercial bank sells its loans at a
discount to a developing country government for local currency which it then uses to
finance an equity investment in the debtor country.
46. A debt-equity swap results in a trade surplus nation forgiving the loans
made to a trade-deficit nation.
47. Eurocurrencies are deposits, denominated and payable in dollars and
other foreign currencies, in banks outside the United States, primarily in London, the
market's center.
SHORT ANSWER
1. Why do countries hold international reserves?
2. How can a bank reduce its exposure to the debt of developing nations?
ESSAY
1. Describe the eurocurrency market.
2. Are international reserve needs different for different exchange rate
regimes?