Chapter Twenty-Three: Macroeconomic Policy in an Open Economy

Table of Contents

1. Chapter Twenty-Three: Macroeconomic Policy in an Open Economy

Chapter Twenty-Three: Macroeconomic Policy in an Open Economy

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Question 1 Under the assumption of perfect capital mobility and a rigidly fixed exchange rate, the BB line is horizontal because: a) The domestic monetary authority fixes an interest rate and the BB line shifts up or down as the domestic policy rate changes. b) Domestic and foreign bonds are perfect substitutes and so the domestic interest rate cannot deviate from the foreign interest rate without causing massive capital inflows or outflows. c) The domestic monetary authority fixes the domestic money stock. d) The current account is always in balance and so capital flows have to be zero. e) Domestic aggregate demand is invariant to the interest rate. Correct.Incorrect. The answer is b) Domestic and foreign bonds are perfect substitutes and so the domestic interest rate cannot deviate from the foreign interest rate without causing massive capital inflows or outflows.Your answer has been saved.

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Question 2 Which of the following is true about the current account at points on the BB line? a) The current account is in balance at each point on the BB line. b) The current account balance improves as GDP rises. c) The current account is in deficit at all points on BB but it can be financed easily through foreign borrowing. d) The current account balance deteriorates as GDP rises (as imports rise relative to exports) and the surplus or deficit can be financed easily at the going world interest rate. e) As the current account is always equal to (minus) the capital account it is indeterminate at all points on the BB line. Correct.Incorrect. The answer is d) The current account balance deteriorates as GDP rises (as imports rise relative to exports) and the surplus or deficit can be financed easily at the going world interest rate.Your answer has been saved.

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Question 3 Monetary policy is powerless to influence real activity under fixed exchange rates and with perfect capital mobility because: a) As the monetary authority lowers interest rates (and/or increase the money supply) this has no effect on domestic aggregate demand. b) The LM curve is vertical. c) Any attempt at changing domestic interest rates would lead to massive capital flows which would change international reserves and force the domestic authorities to reverse the interest rate change. d) Money is neutral in the short and long run whatever the exchange rate regime. e) Prices rise proportionately with the increase in money supply and so the money supply change has no real effect. Correct.Incorrect. The answer is c) Any attempt at changing domestic interest rates would lead to massive capital flows which would change international reserves and force the domestic authorities to reverse the interest rate change.Your answer has been saved.

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Question 4 Monetary policy has a powerful impact on real activity under floating exchange rates because: a) There is a capital inflow when domestic interest rates fall. b) A relaxation of monetary policy causes inflation. c) The economy will be more open to foreign demand shocks. d) Fiscal policy is not able to offset the effects of monetary policy. e) A change in domestic interest rates has a direct effect on domestic investment and, via the exchange rate, affects net exports. Correct.Incorrect. The answer is e) A change in domestic interest rates has a direct effect on domestic investment and, via the exchange rate, affects net exports.Your answer has been saved.

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Question 5 Fiscal policy has a powerful effect on aggregate demand under fixed exchange rates with perfect capital mobility because: a) A fiscal policy stimulus leads to upward pressure on domestic interest rates and to stop the exchange rate appreciating the monetary authorities have to increase the money supply, so the monetary feedback reinforces the fiscal stimulus. b) A fiscal expansion immediately lowers interest rates and this increases investment. c) The multiplier effect leads to higher tax revenue. d) A fiscal policy expansion leads to an increase in net exports. e) The long-run aggregate supply curve is vertical. Correct.Incorrect. The answer is a) A fiscal policy stimulus leads to upward pressure on domestic interest rates and to stop the exchange rate appreciating the monetary authorities have to increase the money supply, so the monetary feedback reinforces the fiscal stimulus.Your answer has been saved.

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Question 6 Fiscal policy is powerless to influence real activity under floating exchange rates because: a) The short-run aggregate supply curve is horizontal. b) A fiscal expansion puts upward pressure on domestic interest rates, and the resulting capital inflows appreciate the exchange rate which reduces net exports. c) The multiplier effect is very small in an open economy. d) Budget deficits can be financed from abroad. e) Monetary policy automatically offsets fiscal policy. Correct.Incorrect. The answer is b) A fiscal expansion puts upward pressure on domestic interest rates, and the resulting capital inflows appreciate the exchange rate which reduces net exports.Your answer has been saved.

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Question 7 Following a discrete devaluation, the J curve arises because: a) Exports respond to the price changes quicker than imports. b) Both exports and imports are price inelastic in the short term, so in domestic currency terms the import bill rises relative to exports. c) The devaluation makes domestic assets more attractive to foreign investors. d) Fiscal policy is usually tightened at the same time as the devaluation. e) Interest rates usually rise to accompany the devaluation. Correct.Incorrect. The answer is b) Both exports and imports are price inelastic in the short term, so in domestic currency terms the import bill rises relative to exports.Your answer has been saved.

8	Question 8 What is meant by the term 'arbitrage'? Hint: re-read 'Why does openness matter?' pp520-21.

9	Question 9 What developments have led to the globalization of financial markets? What are the implications of these changes? Hint: re-read 'Box 23.1: The globalization of financial markets' p520.

10	Question 10 What does the BB curve depict when added to the IS/LM framework? Hint: re-read 'The macro model with capital flows' pp522-24. You should also consider what assumption we are making in drawing the BB curve as a horizontal line.

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Question 11 What can't monetary policy under fixed exchange rates and perfect capital mobility exert any independent influence over real economic activity? Can the same be said for fiscal policy? Hint: re-read 'Policy changes with fixed exchange rates' pp524-26. You may find it useful to draw a flow chart depicting the changes that occur when a government chooses to reduce (or increase) domestic interest rates when the economy is in equilibrium.

12	Question 12 Replicate your analysis under the assumption that a regime of floating exchange rates now exists. Hint: re-read 'Policy changes with floating exchange rates' pp527-31.

13	Question 13 What does the 'J curve' depict? Hint: re-read 'Box 23.2: The J curve' pp530. In answering the question, you may wish to take the next step and consider whether the relationship depicted by the J curve has policy-making significance.

14	Question 14 Why do you think that the pattern of real GDP growth for the countries identified in Chart ii on page 536 broadly follow the same pattern as that of world real GDP growth over the period 1970-2007? Hint: re-read 'Box 23.3: International linkages and the world business cycle' p536

15	Question 15 What are the four main types of financial crisis? Hint: re-read 'Case study 1: The Asian financial crisis of 1997-98' pp535-37. In putting together your answer, you should consider the degree to which they have common origins.

16	Question 16 What are the main factors that contributed to the SE Asian financial crisis of 1997-98? Hint: re-read 'Case study 1: Events in SE Asia 1997-8' p537-39.