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Question 1

Assume the price level is fixed in a small open economy under fixed exchange rates. First consider the policy mix of fiscal and monetary policies that move IS curve to IS´ and the LM curve to LM´, respectively. Suppose instead, the fiscal authorities simple shift the IS curve to IS´ without a coordinated shift of the LM curve. What would we observe in the second case?

a) Without support from the monetary authorities the new IS´ curve will be forced back to IS and the economy will return to A.

b) Without support from the monetary authorities the new IS´ curve will be forced partway back towards IS and the economy will move to a point between A and B.

c) The LM curve will be forced to LM´ anyway even without the policy mix and the economy will move to B just as in the policy mix case.

d) The LM curve will be forced to the right anyway even without the policy mix, though the economy will only move to a point between A and B.

Question 2

The initial equilibrium in the goods and money market for a small open economy is at point A where IS and LM intersect with i*. World interest rates jump upward to i*´. The rightward shift in the IS curve to IS´ that would follow under (A) _____ is due to the (B) _________.

a) (A) fixed exchange rates; (B) increase in government deficits due to higher interest rates

b) (A) fixed exchange rates; (B) lower demand for money due to high interest rates leading to an increased demand for consumption goods

c) (A) flexible exchange rates; (B) exchange rate depreciating

d) (A) flexible exchange rates; (B) exchange rate appreciating

Question 3

Under a fixed exchange rate system (A)_________ would be an exogenous monetary policy instrument, whereas under a flexible exchange rate system (B) ______________ would be an endogenous monetary policy instrument.

a) (A) the exchange rate ; (B) the exchange rate

b) (A) the exchange rate ; (B) the interest rate

c) (A) the interest rate ; (B) the exchange rate

d) (A) the interest rate ; (B) the interest rate

Question 4

Suppose a country with a fixed exchange rate decides to implement a devaluation of its currency and commits to maintaining the new fixed parity. This implies (A) ______________ in the demand for its goods and a monetary (B) _______________.

a) (A) contraction ; (B) contraction

b) (A) contraction ; (B) expansion

c) (A) expansion ; (B) contraction

d) (A) expansion ; (B) expansion

Question 5

With respect to a country having a fixed exchange rate, which of the following statements is not correct?

a) The fixed exchange rate system imposes strict discipline on the central bank.

b) The economy is vulnerable to foreign but not domestic demand disturbances.

c) The Taylor Rule schedule is irrelevant.

d) Shifts in world interest rates can pose a risk to the sustainability of the fixed exchange rate.

Oxford University Press, Online Resource Centre, Chapter 11.

Chapter 11

Instructions

Question 1

Question 2

Question 3

Question 4

Question 5