International Economics, 7e (Husted/Melvin)



International Economics, 7e (Husted/Melvin)

Chapter 17 Basic Theories of the Balance of Payments

Multiple-Choice Questions

1)

If U.S. export contracts are written in terms of foreign currency and import contracts are denominated in domestic currency, a devaluation of the dollar during the currency contract period

A)

should increase the dollar value of exports.

B)

should not have any effect on the dollar value of U.S. imports.

C)

must increase the BOT.

D)

All of the above

Answer:

D

2)

The notion that, following a devaluation, the BOT falls for a while before increasing is called a ________ effect.

A)

relative price

B)

elasticity

C)

J-curve

D)

pass-through

Answer:

C

3)

Suppose that the United Kingdom devalues the pound. If both exports and imports are written in terms of pounds, then the United Kingdom balance of trade ________ during a currency contract period.

A)

improves

B)

worsens

C)

is unaffected

D)

falls for a while before increasing

Answer:

C

4)

The ________ analysis considers the ability of domestic and foreign prices to adjust to devaluation in the short run.

A)

pass-through

B)

absorption

C)

adjustment mechanism

D)

currency contract period

Answer:

A

5)

The shorter the "pass-through" period, the ________ the desirable BOT effects of devaluation on quantities traded will appear.

A)

sooner

B)

longer

C)

bigger

D)

smaller

Answer:

A

6)

The balance of trade can only worsen if income ________ relative to absorption.

A)

increases

B)

decreases

C)

does not change

D)

None of the above

Answer:

B

7)

Empirical evidence regarding the effects of devaluation on the balance of trade indicates that

A)

devaluation generally improves the BOT.

B)

devaluation generally hurts the BOT.

C)

no strong generalizations are possible.

D)

devaluation has no effect on the BOT.

Answer:

C

8)

If devaluation does not improve the BOT, but only the BOP, this implies that

A)

the capital account is in deficit.

B)

the current account is in surplus.

C)

the improvement comes in the capital account.

D)

Both B and C.

Answer:

C

9)

Which of the following are theories of the BOT?

A)

monetary approach

B)

absorption approach

C)

elasticities approach

D)

Both B and C

Answer:

D

10)

Which of the following is not appropriate, if we live in a world of fixed exchange rates?

A)

monetary approach to the exchange rate

B)

elasticities approach

C)

monetary approach to the BOP

D)

absorption approach

Answer:

A

11)

With fixed exchange rates, the adjustment to changes in international monetary conditions comes through

A)

exchange rate changes.

B)

exchange rate changes and international money flows.

C)

international money flows.

D)

None of the above.

Answer:

C

12)

Which of the following is not correct for a small open economy?

A)

She cannot improve her BOT.

B)

She cannot affect the international price of goods.

C)

She cannot affect the foreign interest rate.

D)

All of the above.

Answer:

A

13)

With fixed exchange rates, an increase in the foreign inflation rate, with constant income and domestic credit, will lead to

A)

a change in the exchange rate.

B)

an increase in international reserves.

C)

a decrease in international reserves.

D)

no change in international reserves.

Answer:

B

14)

The ________ analyzes the BOP and exchange rates in terms of money supply and money demand.

A)

elasticities approach

B)

"pass-through of devaluation"

C)

monetary approach

D)

absorption approach

Answer:

C

15)

With a managed float, monetary disequilibrium is eliminated through

A)

international reserve flows.

B)

exchange rate changes.

C)

international reserve flows and exchange rate changes.

D)

None of the above.

Answer:

C

16)

In the case of purely flexible exchange rates, a decrease in domestic real income, with constant prices and domestic credit, will lead to

A)

an increase in international reserves.

B)

the depreciation of the domestic currency.

C)

the appreciation of the domestic currency.

D)

no change in the value of the domestic currency.

Answer:

B

17)

Under a managed float system, central banks can

A)

allow international reserve changes.

B)

let exchange rates adjust to market pressure.

C)

experience reserve changes and exchange rate changes.

D)

All of the above.

Answer:

D

18)

The ________ is a theory of the balance of trade that emphasizes how domestic spending on domestic goods changes relative to domestic output.

A)

absorption approach

B)

monetary approach

C)

pass-through analysis

D)

elasticities approach

Answer:

A

19)

According to the MABP, BOP disequilibria

A)

must be transitory.

B)

are essentially real phenomena.

C)

must be permanent.

D)

are not important.

Answer:

A

20)

Both the ________ do not put a great deal of emphasis on the capital account.

A)

absorption and monetary approaches

B)

monetary and elasticities approaches

C)

elasticities and absorption approaches

D)

None of the above

Answer:

C

True or False Questions

1)

J-curve effects following a devaluation are simply a theoretical issue with no real world importance.

Answer:

False

Explanation:

None Given

2)

The longer the "pass-through" period following a devaluation, the faster the desirable balance of trade effects of a devaluation will appear on quantities traded.

Answer:

False

Explanation:

None Given

3)

The evidence available suggests that the effects of devaluation appear to differ across countries and time so that no strong generalizations regarding the effects of devaluation on the balance of trade and/or balance of payments are possible.

Answer:

True

Explanation:

None Given

4)

If devaluation improves only the BOP, rather than the BOT, this implies that the capital account must have improved following a devaluation.

Answer:

True

Explanation:

None Given

5)

The absorption approach is a theory of the balance of payments that emphasizes how domestic spending on domestic goods changes relative to domestic output.

Answer:

False

Explanation:

None Given

6)

The elasticities approach and the absorption approach are theories of the balance of trade that emphasize trade in real goods and have little to say about the capital account.

Answer:

True

Explanation:

None Given

7)

The international adjustment mechanism for flexible exchange rates is the same as for managed float regimes.

Answer:

False

Explanation:

None Given

8)

An increase in real income with constant prices and domestic credit leads to the same effects under both fixed and purely flexible exchange rates.

Answer:

False

Explanation:

None Given

9)

With a flexible exchange rate, a nation can choose an inflation rate independent of the rest of the world.

Answer:

True

Explanation:

None Given

10)

The net effect of a devaluation on economic growth depends on the mix of capital and labor utilized in the nation's export industries.

Answer:

True

Explanation:

None Given

Essay Questions

1)

What is the difference between the monetary approach to the exchange rate and monetary approach to the balance of payments? Briefly summarize the policy implications of the monetary approach.

Answer:

With the MABP there are not exchange rate changes so international reserve flows respond to changes in PF, Y, and D. With the MAER, there are no reserve flows so the exchange rate changes in response to changes in PF, Y, and D. Policy implications: BOP disequilibria are monetary phenomena that are transitory and can be handled with domestic monetary policy; an increase in domestic income will improve domestic BOP if not offset by domestic credit increases.

2)

Discuss the short-run and long-run views of PPP. Make sure that you explain the underlying adjustment mechanism and theoretical reasoning for each view when answering the question. Which view, do you think, is more likely to represent the real world?

Answer:

If PPP holds in the short run, then capital flows change money supplies and prices quickly. If PPP holds only in the long run, then prices must adjust slowly following a faster adjusting exchange rate.

3)

Write down a model that will allow you to analyze the BOP and exchange rate in a monetary framework. Then, discuss the consequences of an increase in the foreign inflation rate under fixed, flexible, and managed floating systems.

Answer:

R^ - E^ =P^F + Y^ - D^ . If P^F increases, then with fixed rates R^ increases. With a float, E^ falls. With a managed float, (R^ - E^ ) increases with both R^ increasing and E^ falling.

4)

Is the "international adjustment mechanism" for fixed and flexible exchange rates the same? Discuss briefly.

Answer:

No, the answer to 3 will serve as an acceptable answer.

5)

Explain the elasticities and absorption approaches to the BOT. What is the most notable shortcoming of these approaches?

Answer:

The elasticities approach analyzes the effect of devaluation on the trade balance based on elasticities of supply and demand for foreign exchange and international trade. The absorption approach views the trade balance as the difference between what the economy produces and what it takes for domestic use or absorbs. Neither approach considers capital flows.

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