Chapter 14 - Exchange Rates I - The Monetary Approach in the Long Run

QUIZ 6 (Chapter 14), part 1

Question 1 Multiple Choice

The idea that with frictionless trade all goods traded internationally will have the same
equilibrium price no matter which currency they are priced in, is known as:

Answer
a. covered interest parity.
b. arbitrage.
c. the law of one price.
d. relativity.

Question 2 Multiple Choice

The law of one price works under some assumptions. Which of the following is NOT an
assumption for the law of one price?

Answer
a. There is free competition.
b. There is no transportation cost.
c. There are no tariffs.
d. The skill level of workers is identical in both countries.

Question 3 Multiple Choice

If an automobile costs $32,000 in New York and $1 = 0.8 euros, then under the condition of
the law of one price, the cost of the automobile in Rome should be:

Answer
a. 32,000 euros.
b. 40,000 euros.
c. 35,000 euros.
d. 25,600 euros.

Question 4 Multiple Choice

If a basket of goods in the United States costs $1,000, and the same basket of goods in
Japan costs ¥125,000, then for PPP to exist, $1 should trade for ____ Japanese yen.

Answer
a. 4
b. 50
c. 125
d. 125,000
Chapter 14 - Exchange Rates I - The Monetary Approach in the Long Run

Question 5 Multiple Choice

The real exchange rate between two currencies tells us:

Answer
a. changes in the exchange rate over time.
b. how many units of one currency can be purchased with one unit of the home currency.
c. how much in terms of goods and services the home currency will buy in the foreign nation
compared to the home nation.
d. how much depreciation or appreciation has occurred in the home exchange rate.

Question 6 Multiple Choice

If the real exchange rate for a foreign currency falls (a real appreciation), what is the
situation?

Answer
a. It takes more home goods to purchase the same quantity of foreign goods.
b. It takes fewer home goods to purchase the same quantity of foreign goods.
c. The nominal exchange rate has risen as well.
d. The nominal exchange rate has fallen.

Question 7 Multiple Choice

If more home goods are required to buy the same amount of foreign goods, then we say that
foreign currency has experienced:

Answer
a. a nominal appreciation.
b. a nominal depreciation.
c. a real appreciation.
d. a real depreciation.

Question 8 Multiple Choice

If fewer home goods are required to buy the same amount of foreign goods, then we say that
foreign currency has experienced:

Answer
a. a nominal appreciation.
b. a nominal depreciation.
c. a real appreciation.
d. a real depreciation.

Question 9 Multiple Choice

What is the situation when a home currency purchases fewer goods and services at home
than abroad when converted to a foreign currency?

Answer
a. The currency is undervalued.
b. The currency is overvalued.
c. The currency is unstable.
Chapter 14 - Exchange Rates I - The Monetary Approach in the Long Run

d. The currency is appreciating.

Question 10 Multiple Choice

When the Chinese yuan is appreciating against the U.S. dollar, if relative PPP holds, then
this suggests that the U.S. inflation rate:

Answer
a. exceeds the Chinese inflation rate.
b. equals the Chinese inflation rate.
c. exceeds the Chinese interest rate.
d. equals the Chinese interest rate.

Question 11 Multiple Choice

Which of the following statements is NOT a reason for explaining the deviations from PPP?

Answer
a. Some goods are not tradeable.
b. Markets are imperfect and there could be legal obstacles.
c. Prices can be sticky in different countries.
d. There are no transportation costs.

Question 12 Multiple Choice

An example of a non-traded product would be:

Answer
a. corn.
b. haircuts.
c. shoes.
d. aircraft.

Question 13 Multiple Choice

Money can be defined as:

Answer
a. a unit of account.
b. a store of value.
c. a medium of exchange.
d. a unit of account, a store of value, and a medium of exchange.

Question 14 Multiple Choice

Money's function as a medium of exchange is important because:

Answer
a. if there were no money, there would be no common unit of account.
b. if there were no money, society's wealth would be zero.
c. it eliminates the need for inefficient barter.
d. if there were no money, exchanges would be impossible.

Question 15 Multiple Choice

The most restrictive measurement of money is:

Answer
a. M0.
b. M1.
c. M2.
d. M3.

Question 16 Multiple Choice

If nominal income in a nation decreases, economists would predict:

Answer
a. the supply of money will rise.
b. the demand for money will rise.
c. the supply of money will decrease.
d. the demand for money will decrease.

Question 17 Multiple Choice

According to the quantity theory of money, the demand for money is equal to:

Answer
a. nominal income divided by real income.
b. a constant proportion of nominal income.
c. the demand for money held as an asset.
d. real income divided by velocity.

Question 18 Multiple Choice

In general, monetary economic theory states that the demand for money is proportional to:

Answer
a. nominal income.
b. the unemployment rate.
c. the population.
d. the exchange rate.

Question 19 Multiple Choice

The demand for real money balances is:

Answer
a. proportional to nominal income.
b. proportional to real income.
c. disproportional to real GDP.
d. determined by the real rate of interest.

Question 20 Multiple Choice

Assume nominal GDP = PY, and k = the proportion of nominal income that the nation holds
(demands) as money to cover its transactions. Because nominal money supply = nominal
money demand, then:
Chapter 14 - Exchange Rates I - The Monetary Approach in the Long Run

Answer
a. increases in nominal income cause an increase in the money supply.
b. decreases in nominal income cause an increase in the money supply.
c. price increases cause an increase in the money supply.
d. an increase in the money supply causes a proportional increase in nominal income.

Question 21 Multiple Choice

If all else is equal, a nation with greater income will have:

Answer
a. lower prices.
b. higher prices.
c. lower money supply.
d. higher prices and higher money supply.

Question 22 Multiple Choice

If we adjust the supply of money for changes in the price level, we get real balances. The
demand for real balances is proportional to ____.

Answer
a. real GDP
b. the unemployment rate
c. the population
d. the exchange rate

Question 23 Multiple Choice

If we assume that prices adjust in the long run so that the nominal demand for money equals
the nominal supply of money, then:

Answer
a. we can determine changes in exchange rates if absolute PPP holds.
b. absolute PPP will hold.
c. relative PPP will hold.
d. exchange rates will not change.

Question 24 Multiple Choice

Under the monetary approach to exchange rates, if both real money demand and money
supply are greater at home than in foreign markets, then the exchange rate should be:

Answer
a. greater than 1.
b. equal to 1.
c. less than 1.
d. There is not enough information provided to know what the exchange rate should be.

Question 25 Multiple Choice

Under the monetary approach to exchange rates, if there is a rise in a country's home
money supply, and all else is equal, then the exchange rate should:
Chapter 14 - Exchange Rates I - The Monetary Approach in the Long Run

Answer
a. depreciate.
b. hold steady.
c. appreciate.
d. appreciate and then remain steady.

Question 26 Multiple Choice

Under the monetary approach to exchange rates, if the exchange rate has appreciated, this
suggests that:

Answer
a. the home country's money supply has fallen.
b. the foreign country's income has risen.
c. the home country's income has fallen.
d. the home country's money supply has risen.

Question 27 Multiple Choice

When we consider growth rates of the variables, the growth of the price level (inflation) is
equal to:

Answer
a. growth in nominal GDP.
b. growth in real GDP.
c. growth of the monetary aggregate.
d. growth of the nominal supply of money minus the growth rate of real income.

Question 28 Multiple Choice

The long-run relationship between money growth, income growth, and the change in the
price level in a nation is:

Answer
a. money growth = real income growth – change in the price level.
b. real income growth – money growth = change in the price level.
c. change in the price level = money growth – real income growth.
d. real income growth / change in the price level = money growth.

Question 29 Multiple Choice

If Europe has a real GDP growth rate of 5%, and the United States has a real GDP growth
rate of 6%, while money growth in Europe is 7%, and money growth in the United States is
5%, what would the monetary exchange rate model predict for exchange rates in the long
run?

Answer
a. The U.S. dollar would appreciate by 3% against the euro.
b. The U.S. dollar would depreciate by 3% against the euro.
c. The U.S. dollar and the euro would not change against each other because the growth
rates are offsetting.
d. The U.S. dollar would appreciate by 1% against the euro.
Chapter 14 - Exchange Rates I - The Monetary Approach in the Long Run

Question 30 Multiple Choice

If the U.S. growth rate is greater than that of Canada, then the dollar will depreciate:

Answer
a. only if the U.S. inflation rate exceeds Canada's.
b. regardless of the relative inflation rates.
c. only if the U.S. inflation rate is less than Canada's.
d. only if the U.S. inflation rate is less than that of Canada's other trade partners.

Question 31 Multiple Choice

An increase in money supply by 15% in the United States would cause the exchange rate to:

Answer
a. appreciate by 15%.
b. appreciate by 7.5%.
c. depreciate by 15%.
d. stay the same.

Question 32 Multiple Choice

Forecasting exchange rates involves:

Answer
a. knowing the history of exchange rate behavior.
b. assessing data on money supply growth and potential real income growth.
c. understanding the relationship between monetary policy and unemployment.
d. assessing data on money supply and unemployment.

Question 33 Multiple Choice

If we can accurately predict monetary growth, and if the assumption that demand for real
money balances is constant, then we may predict:

Answer
a. changes in exchange rates only.
b. changes in price levels only.
c. both changes in price levels and changes in exchange rates.
d. neither changes in price levels nor changes in exchange rates.

Question 34 Multiple Choice

If prices are flexible and PPP holds, it is possible to forecast the exchange rate in the long
run whenever ______ change in a nation ceteris paribus.

Answer
a. real income and nominal growth rate of the money supply
b. levels of trade and financial flows
c. capital controls
d. short-run nominal interest rates

Question 35 Multiple Choice

Whenever the supply of money is growing at a constant rate, if there is price flexibility and
real income is constant, then:

Answer
a. the price level is growing at a faster rate.
b. the price level is decreasing.
c. the price level is constant.
d. the price level grows at the same rate.

Question 36 Multiple Choice

Empirically, during the period 1975–2005, the relationship between the growth rate of
money, changes in the price level, and changes in the exchange rate was:

Answer
a. perfect.
b. strong but not perfect.
c. weak, but showing some correlation.
d. completely uncorrelated, with a correlation coefficient of zero.

Question 37 Multiple Choice

Factors that could weaken the relationship between money growth rates and changes in
price levels and rates of exchange include:

Answer
a. national differences in variables affecting growth of real income or the demand for money.
b. differences in transportation costs, making trade nearly impossible.
c. differences in the willingness of government to address economic problems with fiscal
versus monetary policy.
d. national differences in variables, differences in transportation costs, and differences in the
willingness of government to address economic problems with fiscal policy.

Question 38 Multiple Choice

Evidence on hyperinflationary periods indicates:

Answer
a. a complete breakdown of the monetary exchange rate theory in the short run.
b. that it takes longer for monetary and price level swings to show up in the exchange rate
data.
c. that the relationship between high inflation and exchange depreciation is much tighter
even in the short run.
d. that the government's inability to control monetary growth led to the currency becoming
completely worthless domestically but ironically more valuable outside the nation.

Question 39 Multiple Choice

Hyperinflation is a condition described by:

Answer
a. a 5% increase in price each year.
b. a sustained increase in price of 50% each month.
Chapter 14 - Exchange Rates I - The Monetary Approach in the Long Run

c. any kind of price increase.

Question 40 Multiple Choice

With an annual inflation of 3.5%, prices will double in _____ years, and if inflation increases
to 10%, prices will double in _______ years.

Answer
a. 20; 7
b. 17; 20
c. 35; 1
d. 2; 4

The End.