anshultongia

A country that uses a fixed exchange rate system is least likely to:

A) run a current account surplus in consecutive years.

B) employ discretionary fiscal policy.

C) use discretionary monetary policy to keep the exchange rate within a narrow band around the target rate.

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Under a fixed exchange rate system, the country gives up discretion about monetary policy and creates domestic currency only up to its holdings of the foreign currency into which it promises to convert the domestic currency. A pegged exchange rate system uses monetary policy to keep the currency’s foreign exchange value within a band relative to a target. A country with a fixed exchange rate remains free to use discretionary fiscal policy. The state of its current and capital accounts will depend on its trade and investment flows.

anshultongia

The benefit of a crawling-peg policy for exchange rates relative to a fixed-rate policy is reduction of risk:

A) in the currency markets.

B) of the government running out of foreign currency.

C) that changes in the inflation rate will cause exchange rates to fluctuate.

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Both fixed-rate and crawling-peg policies are designed to reduce risk in the currency markets. However, when the government periodically resets the rate under a crawling-peg policy, it reduces the risk that it will have too little or too much foreign currency in reserves.

anshultongia

Which of the following statements regarding relative Purchasing Power Parity (PPP) is least accurate?

A) It claims that the exchange rate movements should exactly offset any inflation differential between two countries.

B) In order for relative PPP to hold, countries with higher rates of expected inflation should see their currencies appreciate.

C) Because PPP holds in the long run, it is somewhat useful in exchange-rate determination in the short run.

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In order for relative PPP to hold, countries with higher rates of expected inflation should see their currencies depreciate.

anshultongia

Which of the following statements regarding relative purchasing power parity (PPP) is least accurate?

A) To keep the relative cost of goods and services the same across borders, countries with higher rates of expected inflation should see their currencies depreciate.

B) Short-term inflation differentials are insignificant in regard to exchange rates; only the long-run differentials are important to relative PPP.

C) If relative PPP holds, overvalued currencies will depreciate over time, while undervalued currencies will appreciate.

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According to relative PPP, exchange rates will adjust to inflation differentials. However, empirical evidence indicates that relative PPP tends to hold over the longer term, but not over the short term

anshultongia

The law of one price is:

A) consistent with absolute purchasing power parity (PPP) because it states that identical goods should have the same price in all locations after adjusting for exchange rate effects.

B) not dependent on the potential for arbitrage profits to hold in practice.

C) inconsistent with purchasing power parity (PPP) because it states that identical goods should have the same price in all locations after adjusting for exchange rate effects.

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The law of one price is consistent with absolute purchasing power parity (PPP) because it states that identical goods should have the same price in all locations after adjusting for exchange rate effects.

anshultongia

Which of the following statements regarding purchasing power parity (PPP) is least accurate?

A) Under absolute PPP the foreign price level expressed in domestic currency terms should be equal to the domestic country’s price level.

B) Absolute PPP is similar to the law of one price, except it concerns a basket of goods rather than a single good.

C) Relative PPP states that prices for goods and services are the same whether it is for one good or for a basket of goods.

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Relative PPP does not state that prices for goods and services are the same, only that the rate of change in the FX rate is a function of the inflation differentials between the two countries.

anshultongia

The law of one price applies with respect to:

A) both absolute and relative PPP.

B) absolute purchasing power parity (PPP), but does not apply to relative PPP.

C) relative PPP, but does not apply to absolute PPP.

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The law of one price focuses on a single, clearly comparable good and states that the same good should have the same real prices in all countries. Absolute PPP is an average version of the law of one price. Rather than focusing on a single good, absolute PPP focuses on a weighted average price level of a representative basket of goods and services. Relative PPP holds that exchange rate movements reflect differences in inflation rates between countries. The relative version depends on the growth rates of prices in two countries. It is the rate of inflation (i.e., the relative rate of change in prices) that is critical here.

anshultongia

Which of the following purchasing power concepts depends on the growth rate of prices in two countries?

A) Absolute PPP.

B) International Fisher relation.

C) Relative purchasing power parity (PPP).

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Relative PPP holds that exchange rate movements reflect differences in inflation rates between countries. The relative version depends on the growth rates of prices in two countries.

anshultongia

With respect to the relative purchasing power parity (PPP) equation, compounded inflation rates are applicable when:

A) real interest rates are expected to hold for multiple periods over a certain stated time horizon.

B) inflation rates are expected to hold for multiple periods over a certain stated time horizon.

C) expected exchange rates are expected to hold for multiple periods over a certain stated time horizon.

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Relative PPP holds that exchange rate movements reflect differences in inflation rates between countries. The relative version depends on the growth rates of prices in two countries. It is the rate of inflation that is critical here.
It is necessary to make a slight adjustment to the relative PPP equation to account for the compounded inflation rate over the time horizon if the problem involves multiple periods:

St / S0 = (1 + iFC)t / (1 + iDC)t

anshultongia

Suppose the United States and Europe produce only one good, chocolate. The price of chocolate is $8.25/kg in the United States and €13.60/kg in Europe. According to the law of one price, the $ to € spot exchange rate should be closest to:

A) $0.607.

B) $1.607.

C) $1.648.

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Since the price of chocolate must be the same in both economies, the spot exchange rate should be: