Question

Question 13. After 1973, the world never seemed to be able to return to the Bretton Woods system of fixed exchange rates. One reason often cited for this is that after 1973, OPEC sharply raised the dollar price of oil sold on world markets. For countries other than the US, the abandonment of fixed exchange rates turned into a blessing, in light of the increase in the world price of oil. This is because:

A.         With higher oil prices, these countries’ current account and output would improve. If they were still under a fixed exchange rate system, they would have to contract the money supply in order to keep home interest rates in line with US interest, resulting in lower output.

B.         With higher oil prices, these countries’ current account improve but their output would worsen. If they were still under a fixed exchange rate system, they would have to contract the money supply in order to keep home interest rates in line with US interest, resulting in even lower output.

C.         With higher oil prices, these countries’ current account would worsen, as they are required to spend more on oil imports. With the worsening of the current account, their output/income would decline. Under a fixed exchange rate system, the country would then have to cut the money supply (raise home interest rates) in order to prevent an appreciation of the dollar. Thus, the commitment to the fixed exchange rate would have further reduced home output and income.

D.           With higher oil prices, these countries’ incomes will fall. This, in turn will improve the current account (they import fewer imported goods). The fall in income will also reduce home interest rates, and, under a floating exchange rate, E will rise. The higher E also helps to improve the current account. Under a fixed exchange rate system, E remains constant and this improvement in the current account that comes from a higher E will not emerge. In the end, the current account will improve, despite the fact income/output is lower.

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QUESTION 14. "An even better case study is Singapore. The Singapore Monetary Authority deliberately targets a trend appreciation in the Singapore dollar versus the U.S. dollar in order to maintain price stability." This policy implies that when the Singapore dollar appreciates by more than the target trend rate, the Singapore Monetary Authority should

A. increase its money growth rate   

B. decrease its money growth rate

C. hold its money growth rate constant

D. alter the money growth rate up or down, depending on the unemployment rate

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QUESTION 15. Under a fixed exchange rate system, countries other than the reserve currency country might be forced to import inflationary monetary policies of the reserve currency country. An explanation for this is:

A. As prices in the reserve currency country rise, prices of goods exported to the non-reserve currency countries by the reserve country must rise. Prices in the non-reserve countries must then rise to maintain a fixed exchange rate.

B. As prices in the reserve currency country rise, the current account in other countries will improve. This raises incomes as well as interest rates in countries other than the reserve currency country. The central banks in this countries will then be forced to lower domestic interest rates in order to maintain their fixed parity with the reserve currency.

C. Rising prices in the reserve currency country means that gold prices in that country have also risen. This means that prices in the other countries must also rise in order to maintain a constant fixed price of gold in terms of these other currencies.

D. Rising prices in the reserve currency country means that gold prices in that country have also risen. This means that gold prices in the other countries must fall (or prices of goods must rise) in order to maintain a constant fixed exchange rate.

E. Higher prices in the reserve currency country mean greater prosperity in that country. They then import more goods, and this drives up foreign prices.

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QUESTION 16. We argued in class that under a gold standard, a country experiencing a severe current account deficit

could see the situation reversed (or improved) if countries followed “the rules of the game.”  However, countries did

not always follow the rules.  This is because:

A. They lost the top of the game box and had to make the rules up as they went along.

B. It was easier to allow the price‐specie flow mechanism to work.  

C. The central banks of countries with excessive current account surpluses would often perform an open market purchaseof domestic assets.  The countries with current account deficits would then have to sharply raise their domestic interest rates in order to correct the current account imbalance.

D. The central banks of countries with excessive current account surpluses would often perform an open‐market sale of domestic assets.  Countries with current account deficits would then have to sharply raise their domestic interest rates in order to correct the current account imbalance.

E. The central banks of countries with excessive current account surpluses would often perform an open market sale

of domestic assets.  The countries with current account deficits would then have to sharply decrease their domestic

interest rates in order to correct the current account imbalance and maintain a constant exchange rate.

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Answer 1

Question 13) C.  With higher oil prices, these countries’ current account would worsen, as they are required to spend more on oil imports. With the worsening of the current account, their output/income would decline. Under a fixed exchange rate system, the country would then have to cut the money supply (raise home interest rates) in order to prevent an appreciation of the dollar. Thus, the commitment to the fixed exchange rate would have further reduced home output and income.

Higher oil prices wuld have worsened their current account ( Export - Import ). With flexible exchange system if they have lower output they can cut interest rate to bring up output.

QUESTION 14.) A. increase its money growth rate

Singapore has a small and open economy so a price stabiliy monetary policy based on exchange rate seems ideal. It wants to keep its exchange rate stable within range. When singapore dollar appreciates more then it should increase money growth as such would decrease interest rate as there would be more money in the economy and bringing down interest rate will help people take up loans. Decline in interest rate will induce capital outflow and demand for singapore dollar will decline so it will depreciate and come back within acceptable range.

QUESTION 15) A. As prices in the reserve currency country rise, prices of goods exported to the non-reserve currency countries by the reserve country must rise. Prices in the non-reserve countries must then rise to maintain a fixed exchange rate.

Real exchange rate = Nominal rate x (Domestic price/ Foreign Price)

If foreign price rises , domestic price also has to rise to keep this constant and fixed

QUESTION 16.)

E. The central banks of countries with excessive current account surpluses would often perform an open market sale of domestic assets.  The countries with current account deficits would then have to sharply decrease their domestic interest rates in order to correct the current account imbalance and maintain a constant exchange rate.

The rule sof the game said that when a country has a current account deficit , its centeral bank could decrease interest rates and cause a gold outflow , which would improve it exchange rate and bring it back on par in real terms by raising price.

Other countries did not follow this rule of the game and sold domestic securities to decrease money supply when other country (with deficit ) was sending gold to these countries to increase theire money supply ( gold comes in the country and gets exchanged for currency and hence increasing money supply in the economy). This kept money supply constant and did not allow deficit countries to rise from it.