Q: If the nominal exchange rate between the U.S. dollar and the euro is $$1 = €1.20, the U.S. price level is 110, and the European price level is 100, what is the real exchange rate (in euros per dollar)? Use the formula $$\text{Real exchange rate} = \text{Nominal exchange rate} \times \frac{\text{Domestic price level}}{\text{Foreign price level}}$.

$$1.20 \times \frac{110}{100} = 1.32$$

Question 1

Which of the following best describes the current account in the balance of payments?

Accepted Answer

It records a country's net exports, net income on investments, and net transfers.

Question 2

Suppose the U.S. has a current account deficit of $500 billion. According to the balance of payments identity, what must be true about the financial account (ignoring the capital account)?

Accepted Answer

The financial account must show a surplus of $500 billion.

Question 3

If the nominal exchange rate between the U.S. dollar and the euro is $$1 = €1.20, the U.S. price level is 110, and the European price level is 100, what is the real exchange rate (in euros per dollar)? Use the formula $$	ext{Real exchange rate} = 	ext{Nominal exchange rate} 	imes \frac{	ext{Domestic price level}}{	ext{Foreign price level}}$.

Accepted Answer

$$1.20 	imes \frac{110}{100} = 1.32$$

Question 4

Which of the following would cause the U.S. dollar to appreciate in the foreign exchange market, ceteris paribus?

Accepted Answer

An increase in foreign demand for U.S. financial assets.

Question 5

If the U.S. government runs a budget deficit, what is the likely effect on net exports and the exchange rate, according to the 'twin deficits' hypothesis?

Accepted Answer

Net exports will fall and the dollar will appreciate.

Question 6

Which of the following is NOT a reason why purchasing power parity (PPP) may not hold exactly between two countries?

Accepted Answer

All currencies are backed by gold reserves.

Question 7

A country with a negative net foreign investment (NFI) is:

Accepted Answer

A net borrower from the rest of the world.

Question 8

Suppose the U.S. implements expansionary monetary policy, lowering interest rates. In an open economy, what is the likely effect on net exports and aggregate demand?

Accepted Answer

Net exports increase and aggregate demand rises more than in a closed economy.

Question 9

Which of the following best describes a managed float exchange rate system?

Accepted Answer

Exchange rates are mostly determined by market forces, but governments occasionally intervene.

Question 10

If the U.S. dollar appreciates relative to the euro, what is the likely effect on U.S. exports to Europe and imports from Europe?

Accepted Answer

U.S. exports to Europe will decrease, and imports from Europe will increase.

Question 11

Which of the following equations correctly represents the saving and investment identity in an open economy?

Accepted Answer

$$S = I + NFI$$

Question 12

During the Bretton Woods system, how were exchange rates maintained between member countries?

Accepted Answer

By fixing exchange rates to the U.S. dollar, which was convertible to gold.

Question 13

Suppose the U.S. price level rises by 10% while the nominal exchange rate and the foreign price level remain constant. What happens to the real exchange rate?

Accepted Answer

The real exchange rate increases by 10%.

Question 14

Which of the following is a disadvantage for a developing country that pegs its currency to the U.S. dollar?

Accepted Answer

It may have to support an overvalued or undervalued currency, risking destabilizing speculation.

Question 15

If a country’s national saving is less than its domestic investment, what must be true about its net foreign investment?

Accepted Answer

Net foreign investment is negative.

Question 16

Which of the following would shift the demand for U.S. dollars to the right in the foreign exchange market?

Accepted Answer

An increase in foreign investors’ desire to buy U.S. assets.

Question 17

Which of the following statements about fiscal policy in an open economy is correct?

Accepted Answer

Fiscal policy is less effective in an open economy because some spending leaks into imports and higher interest rates can crowd out net exports.

Question 18

A speculator expects the Japanese yen to appreciate against the U.S. dollar in the near future. What action is the speculator most likely to take?

Accepted Answer

Buy yen now and sell dollars.

Question 19

Which of the following is a key feature of the current international exchange rate system?

Accepted Answer

The U.S. dollar floats against other major currencies.

Question 20

If the U.S. dollar is the world's primary reserve currency, what is one disadvantage for the United States?

Accepted Answer

U.S. exports become more expensive for the rest of the world due to high demand for the dollar.

Macroeconomics in an Open Economy: Study Notes (Chapter 18)

Study Guide - Practice Questions

Study Guide - Flashcards