Beruflich Dokumente
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Chapter 16 Questions
1. If the Federal Reserve buys dollars in the foreign exchange
market but conducts an offsetting open market operation to
sterilize the intervention, what will be the effect on international
reserves, the money supply and the exchange rate?
The purchase of dollars involves a sale of foreign assets that
means that international reserves fall. However, the offsetting
open market purchase means that the monetary base and the
money supply will remain unchanged. There is thus no change in
the expected return on dollar assets, so the demand curve does
not shift and the exchange rate also remains unchanged.
2. If the Federal Reserve buys dollars in the foreign exchange
market but does not sterilize the intervention, what will be the
effect on the international reserves, the money supply and the
exchange rate?
The purchase of dollars involves a sale of foreign assets, which
means that international reserves fall and the monetary base
decreases. The resulting fall in the money supply causes interest
rates to rise and lowers the future price level, thereby raising the
future expected exchange rate. Both of these effects raise the
expected return on dollar assets at any given exchange rate,
shifting the demand curve to the right and raising the equilibrium
exchange rate.
3. For each of the following identify in which part of the balance-ofpayments account it appears (current account, capital account or
net change in international reserves) and whether it is a receipt
or a payment:
a. A British subjects purchase of a share of Johnson &
Johnson stock
A receipt in the capital account;
b. An Americans purchase of an airline ticket from Air France
a payment in the current account;
c. The Swiss governments purchase of US Treasury bills
a receipt in the method of financing;
d. A Japaneses purchase of California Oranges
a receipt in the current account;
e. $50 million of foreign aid to Honduras
a payment in the current account;
f. A loan by an American bank to Mexico
a payment in the capital account
g. An American banks borrowing of Eurodollars
a receipt in the capital account.
currency to the public, and the monetary base will rise. The
resulting rise in the money supply can cause the price level to
rise, leading to a higher inflation rate.
9. If a country wants to keep its exchange rate from changing, it
must give up some control over its money supply. Is this
statement true, false or uncertain? Explain your answer.
True, because when the exchange rate is falling, the central bank
must buy its currency, which lowers its holdings of international
reserves and its monetary base. Similarly, when the exchange
rate is rising, it must sell its currency, which raises its holdings of
international reserves and its monetary base. The necessary
central bank intervention to keep its exchange rate fixed thus
affects the monetary base and hence the money supply.
10.
Why can balance-of-payments deficits force some countries
to implement a contractionary monetary policy?
Countries may implement a contractionary monetary policy when
they decide to intervene in the foreign exchange market and buy
domestic currency to finance the deficit. The result is that they
sell off international reserves and their monetary base falls,
leading to a decline in the money supply.
11.
Balance-of-payments deficits always cause a country to
lose international reserves. Is this statement true, false or
uncertain? Explain your answer.
False. As seen in the chapter, a reserve currency country, such as
the United States, can have its balance of payment deficits
financed by foreign central banks, leaving its international
reserves unchanged.
12.
How can persistent U.S. balance-of-payments deficits
stimulate world inflation?
When other countries buy U.S. dollars to keep their exchange
rates from changing vis--vis the dollar because of the U.S.
deficits, they gain international reserves and their monetary base
increases. The outcome is that the money supply in these
countries grows faster and leads to higher inflation throughout
the world.
13.
Why did the exchange rate peg lead to difficulties for the
countries in the ERM when German reunification occurred?
In the aftermath of German Reunification the Bundesbank faced
rising inflationary pressures. In order to get inflation under
control they raised interest rates significantly to near doubledigit levels. If exchange rates had been allowed to float at this
time then one would have expected the increase in interest rates
to strengthen the deutschemark against the pound. As the
exchange rates were pegged the pound became overvalued
against the deutschemark. In order to maintain the peg the Bank
of England would have had to raise interest rates significantly.
The British were having a very bad recession and thus did not
want to raise interest rates.
14.
Why is it that in a pure flexible exchange rate system, the
foreign exchange market has no direct effects on the monetary
base and money supply? Does this mean that the foreign
exchange market has no effect on monetary policy?
There are no direct effects on the money supply because there is
no central bank intervention in a pure flexible exchange rate
regime; therefore, changes in international reserves that affect
the monetary base do not occur. However, monetary policy can
be affected by the foreign exchange market because monetary
authorities may want to manipulate exchange rates by changing
the money supply and interest rates.
15.
The abandonment of fixed exchange rates after 1973 has
meant that countries have pursued more independent monetary
policies. Is this statement true, false or uncertain? Explain your
answer.
Uncertain. Although after 1973, countries no longer must
intervene in the foreign exchange market to keep their
currencies at a par level and so could pursue more independent
monetary policy, they have not chosen to do so; rather, they
have continued to engage in substantial intervention in the
foreign exchange market. Thus they continue to have substantial
fluctuations in international reserves, which affect their money
supply.
16.
Are controls on capital outflows a good idea? Why or Why
not?
Although capital outflows can harm a country when they lead to
a devaluation of the domestic currency, controls in capital
outflows are generally not thought to be a good idea. They are
seldom effective in a crisis because the private sector figures out
ways to get around them; they may even stimulate further
capital outflows because they weaken confidence in the
government. They also can lead to corruption and may also
encourage governments to procrastinate and not take the steps
necessary to reform their financial systems.
17.
Discuss the pros and cons of controls on capital inflows.
By keeping out capital inflows, there may be less speculative
capital to flow out during a crisis and a lower likelihood that
capital inflows will fuel a lending boom and excessive risk-taking
on the part of banks. On the other hand, capital controls on
inflows keep funds that would be used for productive investment
from entering a country. Capital controls on inflows might also
produce substantial distortions and misallocations of resources
and also lead to corruption.
18.
Why might central banks in emerging-market countries find
that engaging in a lender-of-last-resort operation might be
counterproductive? Does this provide a rationale for having an
international lender of last resort like the IMF?
Engaging in a lender-of-last resort operation is likely to weaken
the credibility of the central bank and lead to inflation and an
even larger depreciation of the domestic currency. Because debt
is short-term and denominated in foreign currency in emergingmarket countries, the depreciation would lead to a deterioration
of balance sheets; thus, the lender-of-last resort operation is
likely to make the financial crisis even worse.
19.
Has the IMF done a good job in performing the role of the
international lender of last resort?
Some critics think not. They believe that IMF lending which was
used to bail out foreign lenders makes financial crises more likely.
These lenders then expect to be bailed out and thus provided
funds that were used to fuel excessive risk taking. Critics also
believe that lending to the Russian government encouraged it to
resist adoption of appropriate reforms to stabilize its financial
system. The IMF has also been criticized for imposing austerity
programs which make it easier for politicians to mobilize public
opinion against doing what is necessary to reform the financial
system. On the other hand, if the IMF had not provided funds to
countries in trouble, their financial crises might have been much
worse.
20.
What steps should an international lender of last resort
take to limit moral hazard?
The international lender of last resort needs to make it clear that
it will extend liquidity only to governments that take measures to
prevent excessive risk taking. It can also reduce moral hazard
by restricting the ability of governments to bail out stockholders
and large uninsured creditors of domestic financial institutions.
Liabilities
$1million
Currencyincirculation
$1million
Liabilities
$1million
Currencyincirculation
$1million
Greek Bank
Greek Bank
Assets
Loan to
1,000
Greek
Customer
Company
Bank
Account
Liabilities
Loan from
1,000
German
Bank
b. The German Bank then withdraws the loan from the Greek
Bank. The Greek Bank then borrows the money from the
Greek central bank. Draw new T-accounts for the German
Bank, The Greek Bank and the Greek Central Bank.
German Bank
Assets
Liabilities
Reserves
1,000
German
1,000
from Greek
Company
Central Bank
Bank
Account
Greek Bank
Assets
Liabilities
Loan to
1,000
Loan from
1,000
Greek
Greek
Customer
Central Bank
Greek Central Bank
Assets
Loan to
1,000
Greek Bank
Reserves
Liabilities
1,000