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Chapter 10 - The International Monetary System

Chapter 10 The International Monetary System

True / False Questions 1. (p. 340) A floating exchange rate is a system under which the exchange rate for converting one currency into another is continuously adjusted depending on the law of supply and demand. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

2. (p. 340) The world's four major trading currencies are free to float against each other. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

3. (p. 340) The exchange rates of all currencies are determined by the free play of market forces. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

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4. (p. 340) When the foreign exchange market determines the relative value of a currency, it is said that the country is adhering to a pegged exchange rate. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

5. (p. 341) Many of the world's most developed countries peg their currencies, primarily to the U.S. dollar or the euro. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

6. (p. 341) The IMF helped several Asian countries deal with the dramatic decline in the value of their currencies during the Asian financial crisis that started in 1997. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

7. (p. 341) Since the Bretton Woods system of floating exchange rates collapsed in 1973, the world has operated with a fixed exchange rate system. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

Chapter 10 - The International Monetary System

8. (p. 341) The task of the IMF was to maintain order in the international monetary system, as stipulated by the Bretton Woods agreement. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Gold Standard

9. (p. 342) The gold standard is the practice of pegging currencies to gold and guaranteeing convertibility. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

10. (p. 342) The amount of a currency needed to purchase one ounce of gold was referred to as the gold monetary value. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

11. (p. 343) A country is said to be in balance-of-trade equilibrium when the income its residents earn from exports is equal to the money its residents pay to people in other countries for imports. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: Strength of the Gold Standard

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12. (p. 343) The United States left the gold standard in 1933, but returned to it in 1934. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: Strength of the Gold Standard

13. (p. 343) The gold standard worked reasonably well from the 1850s until the start of World War I in 1914, when it was abandoned. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: Strength of the Gold Standard

14. (p. 343) More than 70 years after the collapse of the gold standard, there is consensus that the system was a complete failure. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: Strength of the Gold Standard

15. (p. 344) By the start of World War II in 1939, the gold standard was dead. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: Strength of the Gold Standard

Chapter 10 - The International Monetary System

16. (p. 344) The agreement reached at Bretton Woods established two multinational institutions The World Trade Organization and the World Bank. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

17. (p. 344) The Bretton Woods agreement resulted in a commitment to use devaluation as a weapon of competitive trade policy. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

18. (p. 345) The IMF Articles of Agreement were heavily influenced by the worldwide financial collapse, competitive devaluations, and trade wars. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

19. (p. 345) Although monetary discipline was a central objective of the Bretton Woods agreement, it was recognized that a rigid policy of fixed exchange rates would be too inflexible. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

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20. (p. 345) Countries are not allowed to borrow any funds from the IMF without adhering to specific agreements. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

21. (p. 346) If the IMF agrees that the country's balance of payments is in "fundamental disequilibrium," the system of adjustable parities allows for the devaluation of a country's currency by more than 10 percent. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

22. (p. 346) Under the International Development Agency scheme, money is raised through bond sales in the international capital market. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

23. (p. 346) The official name of the World Bank is the International Bank for Reconstruction and Development. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

Chapter 10 - The International Monetary System

24. (p. 347) In the spring of 1971, the United States trade figures revealed that the U.S. was exporting more than it was importing. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

25. (p. 347) President Nixon announced that a new 20 percent tax on imports would remain in effect until U.S. trading partners agreed to revalue their currencies against the dollar in August 1971. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

26. (p. 348) The Bretton Woods agreement had an Achilles' heel: the system could not work if its key currency, the British pound, was under speculative attack. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

27. (p. 348) Following the Jamaica Agreement in 1976, floating rates were declared acceptable. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

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28. (p. 348) Since March 1973, exchange rates have become much more stable and predictable than they were between 1945 and 1973. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

29. (p. 348) Revising the IMF's Articles of Agreement to reflect the new reality of floating exchange rates was the purpose of the Jamaica meeting. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

30. (p. 348) The oil crisis of 1979 is one reason for the volatility of exchange rates since March of 1973. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

31. (p. 349) The rise in value of the dollar between 1980 and 1985 is particularly interesting because it occurred when the United States was running a large and growing trade deficit. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

Chapter 10 - The International Monetary System

32. (p. 349) The rise in the value of the dollar between 1980 an 1985 occurred when the United States was running a large and growing trade deficit, and importing substantially more than it exported. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

33. (p. 350) By 2002, foreigners had started to lose their appetite for U.S. stocks and bonds, and the inflow of money into the United States slowed. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

34. (p. 352) The frequency of government intervention in the foreign exchange market explains why the current system is often referred to as a pegged system. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

35. (p. 352) The breakdown of the Bretton Woods system has not stopped the debate about the relative merits of fixed versus floating exchange rate regimes. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

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36. (p. 352) Monetary policy autonomy and automatic trade balance adjustments are the two main elements of the case against fixed exchange rates. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

37. (p. 353) The case for fixed exchange rates rests on arguments about monetary discipline, speculation, uncertainty, and the lack of connection between the trade balance and exchange rates. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

38. (p. 354) Most economists agree that a fixed exchange rate regime is the most efficient and should be favored. FALSE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

Chapter 10 - The International Monetary System

39. (p. 358) Although Mexico experienced a serious currency crisis in 1995, the recession was relatively short-lived, and by 1997 the country was once more on a growth path, had pared down its debt, and had paid back the $20 billion borrowed from the U.S. government ahead of schedule. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-5 Topic: Crisis Management by the IMF

40. (p. 366) Use of foreign exchange instruments such as the forward market and swaps has increased markedly since the breakdown of the Bretton Woods system in 1973. TRUE

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-6 Topic: Focus on Managerial Implications

Multiple Choice Questions 41. (p. 340) The world's four major trading currencies are all free to float against each other. They include all of the following EXCEPT: A. the British pound. B. the Japanese yen. C. the Spanish peso. D. the U.S. dollar.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

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42. (p. 340) A system of institutional arrangements that countries adopt to govern exchange rates is called: A. the international comparative advantage exchange system. B. the international supremacy exchange system. C. the international exchange process. D. the international monetary system.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

43. (p. 341) When the value of a currency is fixed relative to a reference currency, this is referred to as a: A. variable exchange rate. B. pegged exchange rate. C. linked exchange rate. D. floating exchange rate.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

44. (p. 341) Some countries try to hold the value of their currency within some range against an important reference currency. This is referred to as a: A. dirty-float system. B. free float system. C. pegged float system. D. fixed-variable system.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

Chapter 10 - The International Monetary System

45. (p. 341) The values of a set of currencies are fixed against each other at some mutually agreed on exchange rate in what type of system? A. A permanent exchange rate system B. A floating exchange rate system C. A fixed exchange rate system D. A dirty-float system

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

46. (p. 341) The Bretton Woods conferences occurred in 1944 and established the basic framework for: A. the post-World War II international monetary system. B. the post-World War I economic system. C. the WTO. D. the floating exchange rate system.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

47. (p. 341) The Bretton Woods system called for: A. the IMF to promote development. B. floating exchange rates against the Japanese yen. C. fixed exchange rates against the U.S. dollar. D. floating exchange rates against the U.S. dollar.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

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48. (p. 342) The volume of international trade expanded in the wake of the: A. silver standard. B. Federal Reserve. C. Industrial Revolution. D. balance-of-trade equilibrium.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

49. (p. 342) The gold standard has its origin in: A. the use of the word "gold" to refer to items of value. B. the use of gold coins as a medium of exchange. C. the inherent value placed on gold stones as objects of beauty and value. D. the use of gold bricks as a medium of exchange between countries.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

50. (p. 342) Under the gold standard, the amount of currency needed to purchase one ounce of gold was referred to as the gold _____ value. A. arbitrary B. monetary C. legal D. par

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

Chapter 10 - The International Monetary System

51. (p. 342) As the volume of international trade expanded in the wake of the Industrial Revolution, a more convenient means of financing international trade was needed and the solution was to arrange for payment in: A. paper currency that was converted into gold on demand at a fixed rate. B. paper currency that was converted into silver on demand at a variable rate. C. silver coins that could later on be converted into gold at a fixed rate. D. local resources that were nonconvertible.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

52. (p. 342) By 1880, most of the world's major trading nations, including Great Britain, Germany, Japan, and the United States, had adopted the: A. floating exchange rate system. B. Bretton Woods agreement. C. silver standard. D. gold standard.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

53. (p. 343) The great strength claimed for the gold standard was that it contained a powerful mechanism for achieving _____ by all countries. A. balance-of-trade equilibrium B. economic stability C. interest rate parity D. equal tariff levels

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Gold Standard

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54. (p. 343) The gold standard was abandoned in: A. 1870. B. 1889. C. 1914. D. 1924.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: Strength of the Gold Standard

55. (p. 343) In the 1930s, confidence for the _____ shattered because countries were devaluing their currencies at will. A. fixed exchange system B. currency boards C. gold standard D. International Monetary Fund

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: Strength of the Gold Standard

56. (p. 344) The Bretton Woods conference created two major international institutions. These are: A. the International Monetary Fund and the World Bank. B. the World Trade Organization and the United Nations. C. the World Currency Exchange and the World Bank. D. the Bretton Woods Monetary Fund and the World Trade Organization.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

Chapter 10 - The International Monetary System

57. (p. 344) Which of the following statements does NOT describe the reason for the meeting of representatives from 44 countries in 1944, at the height of World War II, at Bretton Woods? A. They met to strengthen their ties and plan for the future course of war. B. They wanted to avoid the senseless competitive devaluations of the 1930s. C. They aimed to design a new international monetary system. D. They were determined to facilitate postwar economic growth.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

58. (p. 344) The major problem with the _____ was that no multinational institution could stop countries from engaging in competitive devaluations. A. silver standard B. federal reserve standard C. premium standard D. gold standard

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

59. (p. 344) Under the Bretton Woods system, which currency served as the base currency? A. Japanese yen B. British pound C. French franc D. U.S. dollar

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

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60. (p. 344) When discussion on the Bretton Woods system commenced, there was general consensus that: A. fixed exchange rates were desirable. B. floating exchange rates were desirable. C. linked exchange rates were desirable. D. international currency trade was undesirable.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

61. (p. 344) The task of the _____ was to maintain order in the international monetary system, and that of the _____ was to promote general economic development. A. Federal Reserve; Bretton Woods system B. Marshall Plan; floating system C. World Bank; Smithsonian Agreement D. International Monetary Fund; World Bank

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-2 Topic: The Bretton Woods System

62. (p. 344) Under the Bretton Woods agreement, only the dollar remained convertible to gold, at a price of: A. $5 per ounce. B. $20 per ounce. C. $35 per ounce. D. $50 per ounce.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

Chapter 10 - The International Monetary System

63. (p. 345) The IMF Articles of Agreement were heavily influenced by all of the following EXCEPT: A. the worldwide financial boom. B. competitive devaluations. C. trade wars. D. high unemployment.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

64. (p. 345) A fixed exchange rate regime imposes discipline in two ways: (1) the need to maintain a fixed exchange rate puts a brake on competitive devaluations and brings stability to the world trade environment and (2) imposes: A. social discipline on countries, thereby increasing the standard of living. B. economic discipline on countries, thereby increasing gross national product. C. political discipline on countries, thereby curtailing global opportunism. D. monetary discipline on countries, thereby curtailing price inflation.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

65. (p. 345) An increase in money supply typically leads to an increase in: A. employment. B. price inflation. C. gross national product. D. national standard of living.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

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66. (p. 345) _____ are seen as a mechanism for controlling inflation and imposing economic discipline on countries. A. Fixed exchange rates B. Floating exchange rates C. Global exchange rates D. Transnational exchange rates

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

67. (p. 345) In some cases, a country's attempts to reduce its money supply growth and correct a persistent _____ could force the country into recession and create high: A. balance-of-payments deficit; unemployment. B. fixed parity; job opportunities. C. floating exchange rate; employment. D. inflation; revenues.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

68. (p. 345) Two major features of the International Monetary Fund Articles of Agreement fostered flexibility into the monetary system. These features included (1) IMF lending facilities and (2): A. IMF export assistance. B. fixed parities. C. a return to the gold standard. D. adjustable parities.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

Chapter 10 - The International Monetary System

69. (p. 345) The aim of the Bretton Woods agreement was to try to avoid chaos through a combination of: A. intimidation and discipline. B. discipline and flexibility. C. flexibility and freedom. D. freedom and intimidation.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

70. (p. 345) Which of the following is NOT a common IMF mandated-target condition for heavy borrowers from the IMF? A. Controls on government spending B. Tax policy controls C. Controls on exchange rate policies D. Controls on how much can be exported

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

71. (p. 346) The term fundamental disequilibrium' was not defined in the IMF's _____, but it was intended to apply to countries that had suffered permanent adverse shifts in the demand for their products. A. Articles of Agreement B. export assistance C. Structural Adjustment Programs D.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

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72. (p. 346) The Bretton Woods system of fixed exchange rates collapsed in 1973, and since then we have had a: A. stepwise fixed rate exchange system. B. more rigid and enforceable fixed exchange rate system. C. managed-float system. D. combination of managed-float systems and fixed exchange rate systems.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

73. (p. 346) Under the _____, resources are raised through subscriptions from wealthy member countries, and loans go to the poorest countries. Borrowers have 50 years to repay at an interest rate of 1 percent a year. A. International Development Association B. International Bank for Reconstruction and Development C. International Monetary Fund D. Federal Reserve Bank

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

74. (p. 346) The initial mission of the World Bank was to: A. help finance the building of Europe's economy by providing low-interest loans. B. help small businesses establish export operations. C. provide letters of credit on behalf of first-time exporters. D. provide development loans for developing countries in Asia.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

Chapter 10 - The International Monetary System

75. (p. 346) Most economists trace the breakup of the fixed exchange rate system to: A. a worldwide recession. B. the U.S. macroeconomic policy package of 1965-1968. C. the Japanese economic policy of the mid-1970s. D. the European comprehensive policy package of 1960-1964.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

76. (p. 346) Between 1965 and 1968, President Lyndon Johnson backed an increase in U.S. government spending that was financed by: A. domestic loans. B. IMF loans. C. an increase in the money supply. D. an increase in taxes.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

77. (p. 347) In the context of the global money system, in August 1971, President Nixon made the following two announcements: (1) a new 10 percent tax on imports would remain in effect until the trading partners of the U.S. agreed to revalue their currency against the dollar and (2): A. the U.S. planned to call for a second Bretton Woods conference. B. the U.S. would no longer support the World Bank. C. the U.S. planned to devalue its currency by 20 percent. D. the dollar was no longer convertible into gold.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

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78. (p. 347) In 1971, U.S. trade figures showed that for the first time since 1945, the United States was importing more than it was exporting. This set off massive purchases of: A. U.S. dollars. B. German Deutsche Marks. C. Canadian dollars. D. Mexican pesos.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Hard Learning Objective: 10-1 Topic: The Collapse of the Fixed Exchange Rate System

79. (p. 348) Which of the following was NOT one of the main elements of the Jamaica Agreement? A. The establishment of the International Monetary Fund. B. Floating rates were declared acceptable. C. Total annual IMF quotas were increased to $41 billion. D. Gold was abandoned as a reserve asset.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

80. (p. 348) Under which agreement were IMF members permitted to enter the foreign exchange market to even out "unwarranted" speculative fluctuations? A. Bretton Woods System B. GATT C. The Jamaica Agreement D. The North American Free Trade Agreement

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

Chapter 10 - The International Monetary System

81. (p. 348) Which of the following is NOT a contributor to the volatility of exchange rates since 1973? A. The oil crisis in 1971. B. The partial collapse of the European Monetary System in 1992. C. The unexpected rise in the dollar between 1980 and 1985. D. The rapid fall of the Japanese yen against the U.S. dollar between 1985 and 1987.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

82. (p. 348) In 1997, the currencies of South Korea, Indonesia, Malaysia, and Thailand _____ of their value against the U.S. dollar in a few months. A. gained between 50 percent and 80 percent B. lost between 50 percent and 80 percent C. gained between 10 percent and 20 percent D. lost between 10 percent and 20 percent

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

83. (p. 349) Which of the following reasons does NOT help explain the rise in the value of the dollar between 1980 and 1985 despite a large trade deficit? A. Political stability and peace in other parts of the world. B. Strong U.S. economic growth. C. High real interest rates. D. Slow economic growth in the developed countries of Europe.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

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84. (p. 349) The fall in the value of the U.S. dollar between 1985 and 1988 was caused by a combination of: A. government intervention and market forces. B. high inflation and high unemployment. C. a trade deficit and high consumer debt. D. worldwide inflation and high unemployment.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

85. (p. 350) The 1995 Plaza Accord, which was sponsored by the financial ministers of the Group of Five major industrial countries, concluded that it would be desirable if: A. most major currencies appreciated vis--vis the Japanese yen. B. the World Bank converted to a private organization. C. the nations of the world returned to the gold standard. D. most major currencies appreciated vis--vis the U.S. dollar.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

86. (p. 350) In 1987, during the _____, the finance ministers of the Group of Five agreed that exchange rates had been realigned sufficiently and pledged to support the stability of exchange rates around their current levels by intervening in the foreign exchange markets when necessary to buy and sell currency. A. Plaza Accord B. Geneva Convention C. Bretton Woods Conference D. Louvre Accord

AACSB: Reflective Thinking BT: Comprehension Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

Chapter 10 - The International Monetary System

87. (p. 352) Under a _____, some currencies are allowed to float freely, but the majority of currencies are either managed in some way by government intervention or pegged to another currency. A. random monetary system B. regulated standard system C. monitored spot market D. managed-float system

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

88. (p. 352) In recent history, the value of the dollar has been determined by: A. market forces alone. B. government intervention alone. C. market forces and government intervention. D. other currencies.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

89. (p. 352) The case for floating exchange rates has two main elements. These are: A. monetary policy autonomy and automatic trade balance adjustments. B. sporadic trade balance adjustments and monetary policy autonomy. C. the impracticality of the gold standard and monetary policy control. D. monetary policy control and sporadic trade balance adjustments.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

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90. (p. 352) _____ can lead to inflation, which puts downward pressure on fixed exchange rates. A. Monetary expansion B. Monetary standard C. Sporadic trade balance adjustments D. Monetary policy control

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

91. (p. 352) It is argued that a _____ exchange rate regime gives countries monetary policy autonomy. A. restricted B. forward C. fixed D. floating

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

92. (p. 352) _____ requires high interest rates to reduce the demand for money, and to allow an inflow of money from abroad. A. Monetary contraction B. Monetary expansion C. A floating exchange rate D. Monetary discipline

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

Chapter 10 - The International Monetary System

93. (p. 353) The case for fixed exchange rates rests on arguments about monetary discipline, speculation, the lack of connection between the trade balance and exchange rates, and: A. trade balance adjustments. B. uncertainty. C. the impracticality of the gold standard. D. monetary policy autonomy.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

94. (p. 353) By making export cheaper and imports more expensive, _____ should correct a trade deficit. A. uncertainty B. speculation C. monetary discipline D. exchange rate depreciation

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

95. (p. 353) Critics of the floating exchange rate system argue that when foreign exchange dealers see a currency _ depreciation, they tend to: A. overlook the condition. B. buy it keeping in mind the currency's shorter-term prospects. C. sell it regardless of the currency's longer-term prospects. D. buy it keeping in mind the currency's long-term prospects.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

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96. (p. 353) Critics of the floating exchange rate system argue that _____ dampens the growth of international trade and investment. A. trade imbalance B. uncertainty C. a low inflation rate D. monetary discipline

AACSB: Reflective Thinking BT: Knowledge Difficulty: Hard Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

97. (p. 353) _____ adds to the uncertainty surrounding future currency movements that characterizes floating exchange rate regimes. A. The impracticality of the gold standard B. Monetary policy autonomy C. Trade balance adjustments D. Speculation

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

98. (p. 355) Under a pegged exchange rate regime, a country will peg the value of its currency to: A. an index of world currencies maintained by the World Bank. B. that of a major currency. C. an index of "peer nation" currencies. D. an index of its historic currency rates.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

Chapter 10 - The International Monetary System

99. (p. 355) When a country's exchange rate is allowed to fluctuate against other currencies within a target zone, it is operating under a(n): A. managed-float system. B. currency board. C. conventional pegged system. D. adjustable pegged system.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

100. (p. 355) There is some evidence that adopting a pegged exchange rate regime: A. reduces unemployment in a country. B. moderates inflationary pressure in a country. C. increases global GNP. D. decreases global GNP.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

101. (p. 355) _____ experience during the 1997 Asian currency crisis added a new dimension to the debate over how to manage a pegged exchange rate. A. Japan's B. Taiwan's C. Hong Kong's D. Indonesia's

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

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102. (p. 355) A _____ commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate. A. floating system B. currency board C. certified commission D. gold standard

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

103. (p. 355-356) Which of the following countries does NOT currently operate under the currency board system? A. Hong Kong B. Argentina C. Mexico D. Bulgaria

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

104. (p. 356) If local inflation rates remain higher than the inflation rate in the country to which the currency is pegged, the countries with currency boards can become: A. efficient. B. undervalued. C. economic growth achievers. D. uncompetitive.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

Chapter 10 - The International Monetary System

105. (p. 356) The economic collapse in _____ in 2001 and the subsequent decision to abandon its currency board dampened much of the enthusiasm for this mechanism of managing exchange rates. A. Bulgaria B. Hong Kong C. Argentina D. Estonia

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

106. (p. 356) Many observers believed that the collapse of _____ in 1973 would diminish the role of the IMF within the international monetary system. A. Japan B. Bretton Wood systems C. China D. the World Bank

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-4 Topic: Crisis Management by the IMF

107. (p. 357) A _____ occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency or forces authorities to expend large volumes of international currency reserved and sharply increase interest rates to defend the prevailing exchange rate. A. currency disruption B. monetary disruption C. banking crisis D. currency crisis

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

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108. (p. 357) A _____ refers to a situation in which a loss of confidence in the banking system leads to a run on banks, as individuals and companies withdraw their deposits. A. banking crisis B. currency crisis C. federal reserve crisis D. monetary crisis

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

109. (p. 357) A _____ occurs when a country cannot service its foreign debt obligations. A. banking crisis B. currency crisis C. monetary crisis D. foreign debt crisis

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-5 Topic: Crisis Management by the IMF

110. (p. 357) Which of the following is NOT a type of financial crisis that has occurred over the past 30 years? A. Gold crisis B. Currency crisis C. Banking crisis D. Foreign debt crisis

AACSB: Reflective Thinking BT: Knowledge Difficulty: Easy Learning Objective: 10-5 Topic: Crisis Management by the IMF

Chapter 10 - The International Monetary System

111. (p. 357) The Mexican currency crisis and the Asian financial crisis were the result of all of the following EXCEPT: A. excessive foreign borrowing. B. a weak banking system. C. low inflation rates. D. a poorly regulated banking system.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

112. (p. 358) In December 1994, the Mexican government abruptly announced a(n) _____, which exacerbated the sale of the peso and contributed to the rapid 40 percent drop in its value. A. increase in the money supply B. currency devaluation C. trade deficit D. pegged regime

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

113. (p. 358) The financial crisis that erupted across _____ during the fall of 1997 has emerged as the biggest challenge the IMF has had to deal with. A. Eastern Europe B. Southeast Asia C. Central America D. South America

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

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114. (p. 359-360) Which of the following did NOT contribute to the Asian crisis of 1997? A. The investment boom B. The debt bomb C. Excess capacity D. Expanding exports

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

115. (p. 360) A building boom in _____ resulted in excess capacity in residential and commercial property. By early 1997, an estimated 365,000 apartment units were unoccupied in the capital. A. Japan B. Bangkok C. Indonesia D. Taiwan

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

116. (p. 361) According to the text, the Asian meltdown began in mid-1997 in _____ when it became clear that several key financial institutions were on the verge of default. A. Indonesia B. China C. Thailand D. Malaysia

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

Chapter 10 - The International Monetary System

117. (p. 362) Which of the following is NOT one of the IMF stipulations imposed on Indonesia after it was offered a $37 billion rescue deal assembled by IMF along with the World Bank and the Asian Development Bank? A. Close a number of troubled banks B. Balance the budget C. Increase public spending D. Remove government subsidies on basic foodstuffs and energy

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

118. (p. 363) When people behave recklessly because they know they will be saved if things go wrong, what problem is occurring? A. Moral hazard B. Ethical breakdown C. Probability gambling D. Hazardous intent

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

119. (p. 363-365) Which of the following is NOT a common criticism of the IMF? A. Inappropriate policies for many countries B. More beneficial to rich countries than poor countries C. Moral hazards D. Lacks any real mechanism for accountability

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

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120. (p. 366) Contrary to the predictions of the purchasing power parity theory, exchange rate movements during the 1980s and 1990s: A. did not seem to be strongly influenced by relative inflation rates. B. closely followed the predictions of purchasing power parity theory. C. were marked by extremely low volatility. D. were marked by low volume of speculative trades.

AACSB: Analytic skills BT: Comprehension Difficulty: Hard Learning Objective: 10-6 Topic: Focus on Managerial Implications

Essay Questions 121. (p. 341) What is a managed or dirty-float system?

In a managed or dirty-float system, governments intervene to influence the value of their currency. It is a float because in theory, the value of the currency is determined by market forces.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard

Chapter 10 - The International Monetary System

122. (p. 342-344) Describe why and when the gold standard was implemented. What were the strengths of the gold standard? Why and when was it abandoned?

The gold standard had its origin in the use of gold coins as a medium of exchange, unit of account, and store of valuea practice that dates back to ancient times. The gold standard was implemented during the Industrial Revolution, when the volume of international trade made shipping large quantities of gold and silver around the world impractical. Instead, payment could be made in paper currency that was converted into gold on demand at a fixed rate. The great strength claimed for the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium by all countries. This adjustment mechanism seems so attractive and simple that even today, some people believe the world should return to the gold standard. The gold standard worked reasonably well from the 1870s until the start of World War I, when it was abandoned. During the war, several governments financed military expenditures by printing money. This resulted in inflation, and price levels were higher everywhere. Many countries returned to the gold standard after the war, but some governments found that they could not satisfy the demand for gold without seriously depleting their gold reserves. Confidence in the system was shattered because most countries started devaluating their currencies against gold at will, which meant that one could no longer be certain how much gold a currency could buy. By the start of World War II in 1939, the gold standard was dead, replaced by a fixed exchange rate system established by the Bretton Woods agreement.

AACSB: Reflective Thinking BT: Comprehension Difficulty: Medium Learning Objective: 10-1 Topic: The Gold Standard, Strength of the Gold Standard

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123. (p. 344-346) Describe what happened at the 1944 Bretton Woods conference. Are the monetary principles established by the Bretton Woods conference still in effect today?

In 1944, at the height of World War II, representatives from 44 countries met at Bretton Woods, New Hampshire, to design a new international monetary system. The purpose of the conference was to build an economic order that would facilitate postwar economic growth and cooperation. The following primary initiatives resulted from the conference: a) The establishment of the International Monetary Fund (IMF). b) The establishment of the World Bank. c) A call for the establishment of a set of fixed currency exchange rates that would be policed by the IMF. d) A commitment not to use devaluation as a weapon of competitive trade policy. The task of the IMF would be to maintain order in the international monetary system, and the World Bank was designed to promote general economic development. In regard to currency exchange rates, all countries were to fix the value of their currency in terms of gold but were not required to exchange their currencies for gold. Only the U.S. dollar remained convertible into gold - at a price of $35 per ounce. Each other country decided what it wanted its exchange rate to be vis--vis the dollar and then calculated the gold par value of its currency based on that selected dollar exchange rate. All participating countries agreed to try to maintain the value of their currency within 1 percent of the par value. Today, the IMF and the World Bank still play a role in the international monetary system. The system of fixed exchange rates established at Bretton Woods worked well until the late 1960s, when it began to show signs of strain. The system finally collapsed in 1973, and since then we have had a managed-float system.

AACSB: Reflective Thinking BT: Comprehension Difficulty: Medium Learning Objective: 10-1 Learning Objective: 10-2 Topic: The Bretton Woods System, The Collapse of the Fixed Exchange Rate System

Chapter 10 - The International Monetary System

124. (p. 346) Describe the role of the World Bank in the international community. How does the World Bank contribute to the overall stability of the global monetary system?

The World Bank was established by the 1944 Bretton Woods agreement. The official name for the World Bank is the International Bank for Reconstruction and Development (IBRD). The bank's initial mission was to help finance the building of Europe's war-torn economy by providing low-interest loans. As it turned out, the role of the World Bank in Europe was overshadowed by the Marshall Plan, under which the U.S. lent money directly to European nations to help them rebuild in the aftermath of World War II. As a result, the bank turned its attention to lending money for development in Third World nations. Although the World Bank does not play a direct role in monetary policy, it contributes to the global money system by providing low interest loans to developing countries. These loans, which are used for such things as public-sector projects (i.e. power stations, roads, etc.), agricultural development, education, population control, and urban development, are intended to promote economic development and increase the standard of living in developing countries. The bank lends money under two schemes. Under the IBRD scheme, money is raised through bond sales in the international capital market. Borrowers pay a market rate of interestthe bank's cost of funds plus a margin for expenses. This "market" rate is lower than commercial banks' market rate. Under the IBRD scheme, the bank offers low-interest loans to risky customers whose credit rating is often poor. A second scheme is overseen by the International Development Association (IDA), an arm of the bank created in 1960. Resources to fund IDA loans are raised through subscriptions from wealthy members such as the United States, Japan, and Germany. IDA loans go only to the poorest countries. Borrowers have 50 years to repay at an interest rate of 1 percent a year. The world's poorest nations receive grants and noninterest loans.

AACSB: Reflective Thinking BT: Comprehension Difficulty: Medium Learning Objective: 10-2 Topic: The Bretton Woods System

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125. (p. 348) When was the Jamaica Agreement established and for what reason? How did it affect the foreign exchange rate system, and what were its main elements?

Following the collapse of the fixed exchange rate regime, IMF members met in Jamaica and established a floating exchange rate regime. The Jamaica meeting revised the IMF's Articles of Agreement to reflect the new reality of floating exchange rates. The agreement includes the following elements: (1) Floating rates were declared acceptable. (2) Gold was abandoned as a reserve asset. (3) Total annual IMF quotas were increased to $41 billion, benefiting non-oilexporting, less developed countries most.

AACSB: Reflective Thinking BT: Comprehension Difficulty: Medium Learning Objective: 10-1 Topic: The Floating Exchange Rate Regime

Chapter 10 - The International Monetary System

126. (p. 352-354) Describe the difference between fixed and floating exchange rates. Which is better? Explain your answer.

Under a fixed rate system, the value of a currency is fixed (usually in terms of U.S. dollars) and is only allowed to change under a specific set of circumstances. The value of a fixed rate system is that it introduces monetary discipline (on a country level), discourages currency speculation, reduces uncertainty (in regard to future currency movements), and, according to the proponents of fixed rates, has little or no effect on trade balance adjustments. In contrast, under a floating rate system, currencies are allowed to float freely (in practice, the majority of floating rate systems are either managed in some way by government intervention or are pegged to another currency). The benefits of a floating rate system is that it gives countries monetary policy autonomy and, according to proponents, provides a way for countries to correct trade deficits (i.e. an exchange rate depreciation should correct a trade balance by making a country's exports cheaper and its imports more expensive). There is no right or wrong answer to this question - we simply do not know which system is better. We do know that a fixed rate system modeled along the lines of the Bretton Woods system will not work. Conversely, advocates of a fixed rate system argue that speculation is a major disadvantage of floating rates. Perhaps a modified fixed rate system will produce the type of economic stability that will contribute to greater growth in international trade and investments.

AACSB: Reflective Thinking BT: Comprehension Difficulty: Hard Learning Objective: 10-3 Topic: Fixed versus Floating Exchange Rates

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127. (p. 355) What is a pegged exchange rate? How does it work? What is the advantage of a pegged exchange rate regime?

Under a pegged exchange rate regime, a country will peg the value of its currency to that of a major currency so that, for example, as the United States dollar rises in value, its own currency rises, too. Pegged exchange rates are popular among many of the world's smaller nations. As with a full fixed exchange rate regime, the great virtue claimed for a pegged exchange rate regime is that it imposes monetary discipline on a country and leads to low inflation.

AACSB: Reflective Thinking BT: Comprehension Difficulty: Medium Learning Objective: 10-4 Topic: Exchange Rate Regimes in Practice

128. (p. 357) Describe the three broad types of financial crises that have occurred over the past 30 years and have required IMF involvement.

The three types of crises are a currency crisis, a banking crisis, and a foreign debt crisis. A currency crisis occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency or forces authorities to expend large volumes of international currency reserves and sharply increase interest rates to defend the prevailing exchange rate. A banking crisis refers to a loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits. A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations, whether private-sector or government debt.

AACSB: Reflective Thinking BT: Knowledge Difficulty: Medium Learning Objective: 10-5 Topic: Crisis Management by the IMF

Chapter 10 - The International Monetary System

129. (p. 357-358) Write a short note on the Mexican currency crisis of 1995.

The Mexican peso had been pegged to the dollar since the early 1980s when the IMF made it a condition for lending money to the Mexican government to help bail the country out of a 1982 financial crisis. Under the IMF-brokered arrangement, the peso had been allowed to trade within a tolerance band of plus or minus 3 percent against the dollar. The band was also permitted to "crawl" down daily, allowing for an annual peso depreciation of about 4 percent against the dollar. The IMF believed that the need to maintain the exchange rate within a fairly narrow trading band would force the Mexican government to adopt stringent financial policies to limit the growth in the money supply and contain inflation. Until the early 1990s, it looked as if the IMF policy had worked. However, the strains were beginning to show by 1994. Since the mid-1980s, Mexican producer prices had risen 45 percent more than prices in the United States, and yet there had not been a corresponding adjustment in the exchange rate. By late 1994, Mexico was running a $17 billion trade deficit, which amounted to some 6 percent of the country's gross domestic product, and there had been an uncomfortably rapid expansion in public- and private-sector debt. Despite these strains, Mexican government officials had been stating publicly that they would support the peso's dollar peg at around $1 = 3.5 pesos by adopting appropriate monetary policies and by intervening in the currency markets if necessary. Encouraged by such statements, $64 billion of foreign investment money poured into Mexico between 1990 and 1994 as corporations and money managers sought to take advantage of the booming economy. However, many currency traders concluded the peso would have to be devalued, and they began to dump pesos on the foreign exchange market. The government tried to hold the line by buying pesos and selling dollars, but it lacked the foreign currency reserves required to halt the speculative tide. In midDecember 1994, the Mexican government abruptly announced a devaluation. Immediately, much of the short-term investment money that had flowed into Mexican stocks and bonds reversed its course, as foreign investors bailed out of peso-denominated financial assets. This exacerbated the sale of the peso and contributed to the rapid 40 percent drop in its value. The IMF stepped in again, this time with the U.S. government and the Bank for International Settlements. Together the three institutions pledged close to $50 billion to help Mexico stabilize the peso and to redeem $47 billion of public- and private-sector debt that was set to mature in 1995. Without the aid package, Mexico would probably have defaulted on its debt obligations, and the peso would have gone into free fall. The IMF insisted on tight monetary policies and further cuts in public spending, both of which helped push the country into a deep recession. However, the recession was relatively short-lived, and by 1997 the country was once more on a growth path, had pared down its debt, and had paid back the $20 billion borrowed from the U.S. government ahead of schedule.

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AACSB: Reflective Thinking BT: Comprehension Difficulty: Hard Learning Objective: 10-5 Topic: Crisis Management by the IMF

Chapter 10 - The International Monetary System

130. (p. 368) How do businesses influence government policy toward international trade?

As major players in the international trade and investment environment, businesses can influence government policy toward the international monetary system. For example, intense government lobbying by U.S. exporters helped convince the U.S. government that intervention in the foreign exchange market was necessary. With this in mind, business can and should use its influence to promote an international monetary system that facilitates the growth of international trade and investment. Whether a fixed or floating regime is optimal is a subject for debate. However, exchange rate volatility such as the world experienced during the 1980s and 1990s creates an environment less conducive to international trade and investment than one with more stable exchange rates. Therefore, it would seem to be in the interests of international business to promote an international monetary system that minimizes volatile exchange rate movements, particularly when those movements are unrelated to long-run economic fundamentals.

AACSB: Reflective Thinking BT: Comprehension Difficulty: Medium Learning Objective: 10-6 Topic: Focus on Managerial Implications

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