ECON 4423: INTERNATIONAL FINANCE

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1 University of Colorado at Boulder Department of Economics ECON 4423: INTERNATIONAL FINANCE Final Examination Fall 2005 Name: Answer Key Student ID: Instructions: This test is 1 1/2 hours in length. You may use a hand calculator No Cell Phones Answer all questions. Section 1: Multiple Choice. Section 2: Problems. This test is x pages long (including cover). 1

2 Section 1: Multiple Choice Each question is worth 5 points, for a total of 60 points. 1. In the short run, with prices fixed, how would an increase in government spending affect the DD-AA schedule? A. It will increase output and appreciate the currency. B. It will increase output and depreciate the currency. C. It will decrease output and appreciate the currency. D. It will decrease output and depreciate the currency. Answer: A 2. Which one of the following statements is most accurate? A. In the long run, foreign output depends only on the available domestic supplies of factors of production. B. In the short run, domestic output depends only on the available domestic supplies of factors of production. C. In the long run, domestic output depends only on the available domestic supplies of factors of production. D. In the long run and in the short run, domestic output depends only on the available domestic supplies of factors of production. Answer: C 3. Which one of the following statements is most accurate? A. Factors of production can only be over-employed in the short run. B. Factors of production can only be under-employed in the short run. C. Factors of production can be over- or under- employed in the long run. D. Factors of production can be over- or under- employed in the short run. 4. The current account balance is A. the supply of a country s exports less the country s own demand for imports. B. the demand for a country s exports plus the country s own demand for imports. C. the country s own demand for imports less the demand for a country s exports. D. the demand for a country s exports less the country s own demand for imports. 5. Which one of the following statements is the most accurate? A. An increase in the real exchange rate and an increase in disposable income improve the current account. B. A decrease in the real exchange rate and a decrease in disposable income improve the current account. C. A decrease in the real exchange rate and a decrease in disposable income improve the current account. D. An increase in the real exchange rate and a decrease in disposable income improve the current account. 2

3 6. In the short-run, any rise in the real exchange rate, EP*/P, will cause A. an upward shift in the aggregate demand function and a reduction in output. B. an upward shift in the aggregate demand function and an expansion of output. C. a downward shift in the aggregate demand function and an expansion of output. D. an downward shift in the aggregate demand function and a reduction in output. E. an upward shift in the aggregate demand function, but it leaves output intact. Answer: B 7. In the short run, any rise in the foreign price level, P*, will cause A. an upward shift in the aggregate demand function and an expansion of output. B. an upward shift in the aggregate demand function and a reduction in output. C. a downward shift in the aggregate demand function and an expansion of output. D. a downward shift in the aggregate demand function and a reduction in output. E. an upward shift in the aggregate demand function but leaves output intact. 8. Using the DD AA framework, which one of the following statements is the most accurate? A. Only monetary policy can bring the economy to full employment. B. Only fiscal policy can bring the economy to full employment. C. Only both monetary and fiscal policies can bring the economy to full employment. D. Neither policy is capable of bringing the economy to full employment. E. Monetary policy by itself or fiscal policy by itself can bring the economy to full employment. Answer: E 9. Fiscal Expansion under a fixed exchange rate has what effect(s) on the economy? A. The money supply decreases. B. Output decreases. C. The exchange rate increases. D. The exchange rate decreases initially but then returns to its original point. E. Output is unchanged.. Fiscal expansion under a fixed exchange rate shifts the DD schedule outward, thereby causing an increase in output and a decrease in the exchange rate. However, with an accompanying outward shift of the AA schedule, output increases, and the exchange rate shifts outward. This shifts the exchange rate outward to its initial point. 10. Which one of the following statements is most true? A. Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline. B. Any central bank purchase of assets results in an increase in the domestic money supply, while any central bank sale of assets causes the money supply to decline. C. Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decline. D. Any central bank purchase of assets automatically results in a decrease in the domestic money supply, while any central bank sale of assets automatically causes the money supply to increase. E. None of the above statement is true. Answer: A 3

4 11. Which one of the following statements is the most accurate? A. Fiscal policy has the same effect on employment under fixed and flexible exchange rate regimes. B. Fiscal policy affects employment less under fixed than under flexible exchange rate regimes. C. Fiscal policy affects employment more under fixed than under flexible exchange rate regimes. D. Fiscal policy cannot affect employment under fixed exchange rate but does affect output under flexible exchange rate regimes. E. None of the above statements is true. Answer: C 12. Under fixed exchange rate, which one of the following statements is the most accurate? A. Devaluation causes a decrease in output, a decrease in official reserves, and a contraction of the money supply. B. Devaluation causes a rise in output, a rise in official reserves, and an expansion of the money supply. C. Devaluation causes a rise in output and a rise in official reserves. D. Devaluation causes a rise in output and an expansion of the money supply. E. Devaluation causes a rise in official reserves and an expansion of the money supply. Answer: B Section 2: Short Questions Each question is worth 10 points, for a total of 60 points. Points allocated to explanation/computation only. Question 1. True, false, or uncertain: In a world where the stock of money grows continually, the long-run rate of inflation of a country is independent of its exchange rate regime Question 2. Imagine that Congress passes a constitutional amendment requiring the U.S. government to maintain a balanced budget at all times. Thus, if the government wishes to change government spending, it must change taxes by the same amount. The constitutional amendment implies that the government can no longer use fiscal policy to affect employment and output. Question 3. The Central Bank of Saudi Arabia pegs the Riyal to the United States Dollar at a price of 3.75 Riyal per dollar. Describe a monetary policy intervention that the Central Bank of Saudi Arabia must pursue in response to a temporary fiscal expansion in the United States. How would this show on the AA-DD graph? Question 4. A large (temporary) expansionary shock to the demand for money causes a recession. Using the AA-DD schedules, discuss the effects of countercyclical fiscal and monetary policies on output and the exchange rate. Question 5. Using diagrams, fully describe the impact of a permanent reduction in money supply on output, interest rates, exchange rates (nominal and real), and prices. Your description must explain the behavior on the money market, the foreign exchange market, and the goods market. 4

5 Question 6. The Central Bank of the Bahamas pegs the US dollar. The Bank believes that a reduction of home interest rates would stimulate investment. Using the appropriate diagrams, describe a temporary monetary policy and sterilized intervention that maintain a fixed exchange rate, but lower home interest rates. For this question, you must assume the existence of a risk premium. 5

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