TBChap 011

Chapter 11
The International Monetary System
True / False Questions
1. The international monetary system refers to the institutional arrangements that govern exchange
rates.
True False
2. The gold standard called for fixed exchange rates against the U.S. dollar.
True False
3. The agreement reached at Bretton Woods established the International Monetary Fund (IMF) and the
World Bank.
True False
4. Implementing a fixed exchange rate regime increases the price inflation in countries.
True False
5. World Bank offers low-interest loans to risky customers whose credit rating is often poor.
True False
6. The fixed exchange rate system established at Bretton Woods failed due to speculative pressures on
the U.S. dollar.
True False
11-1
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Education.
7. Gold was declared as the formal reserve asset in the Jamaica agreement of 1976.
True False
8. Market forces have produced a stable dollar exchange rate under a floating exchange rate regime.
True False
9. Fixed exchange rates lead to speculation and uncertainty in the value of currencies.
True False
10. Adopting a pegged exchange rate regime increases the inflationary pressures in a country.
True False
11. A country that introduces a currency board commits itself to converting its domestic currency on
demand into another currency at a fixed exchange rate.
True False
12. Interest rates adjust automatically under a strict currency board system.
True False
13. The International Monetary Fund's original function was to provide a pool of money from which
members could borrow in the short term.
True False
14. The International Monetary Fund made pegging the Mexican peso to the dollar, a condition for
lending money to the Mexican government in the 1980s.
True False
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Education.
15. Government projects were a factor behind the investment boom in most Southeast Asian economies.
True False
16. The quality of investments declined significantly in the Asian countries during the 1990s.
True False
17. In the 1990s, most of the borrowing by the companies who invested in Asian countries had been in
local currencies.
True False
18. Moral hazard arises when people behave recklessly because they know they will be saved if things go
wrong.
True False
19. The current system of foreign exchange is a mixed system of government intervention and speculative
activity.
True False
20. Firms should not utilize the forward exchange market when they are faced with uncertainty about the
future value of currencies.
True False
21. An effective business strategy to reduce economic exposure is to contract out high value-added
manufacturing.
True False
Multiple Choice Questions
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Education.
22. The _____ refers to the institutional arrangements that govern exchange rates.
A. World Bank
B. international monetary system
C. currency exchange
D. gold standard
23. A _____ means the value of a currency is fixed relative to a reference currency.
A. pegged exchange rate

B. floating exchange rate
C. managed float system
D. fixed exchange rate
24. When a country tries to hold the value of their currency within some range against an important
reference currency such as the U.S. dollar without adopting a formal pegged rate, it is referred to as a
_____.
A. gold standard
B. pegged float
C. dirty float
D. currency peg
25. The amount of a currency needed to purchase one ounce of gold was referred to as the _____.
A. golden rule
B. gold standard
C. pegged gold value
D. gold par value
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Education.
26. A country is said to be in balance-of-trade equilibrium when:
A. the income its residents earn from exports is equal to the money its residents pay to other countries
for imports.
B. it produces all the goods needed for domestic consumption.
C. the income its residents earn from imports is equal to the money its residents pay to other countries
for exports.
D. it produces all the goods needed for exportation.
27. Under a pegged exchange rate regime, a country:
A. commits itself to converting its domestic currency on demand into another currency at a fixed
exchange rate.
B. will peg the value of its currency to that of a major currency.
C. valuates its currency without attaching it to a reference currency.
D. follows the foreign exchange market to determine the relative value of a currency.
28. International Development Association loans:
A. receive direct funding from the World Bank.

B. must be countersigned by a partnering, wealthy country such as the United States, Japan, or
Germany.
C. are funded through subscriptions from wealthy members.
D. receive direct funding from the International Monetary Fund.
29. International Monetary Fund members were _____ in the Jamaica agreement.
A. not permitted to sell their own gold reserves

B. permitted to sell their own gold reserves, but only at the price set by IMF
C. required to hold their gold reserves in escrow
D. permitted to sell their own gold reserves at the market price
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Education.
30. The value of U.S dollar increased between 1980 and 1985:
A. despite running a growing trade deficit.

B. despite exporting substantially more that it imported.
C. because of a growing trade surplus.
D. because the country's status as a world financial leader was becoming apparent.
31. The rise in the value of the dollar between 1985 and 1988:
A. gave U.S goods a competitive advantage over others.

B. made imports relatively cheap.
C. gave U.S. goods a comparative advantage over others.
D. made imports expensive.
32. Advocates of a _____ argue that removal of the obligation to maintain exchange rate parity would
restore monetary control to a government.
A. fixed exchange rate regime

B. dirty-float system
C. floating exchange rate regime
D. pegged exchange rate regime
33. The monetary autonomy argument is supported by the advocates of _____.
A. a dirty-float system
B. fixed exchange rates
C. pegged exchange rates
D. floating exchange rates
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Education.
34. Supporters of floating exchange rates:
A. argue that floating rates help adjust trade imbalances.

B. argue that floating rates lead to a more stable world monetary system.
C. claim that trade deficits are determined by the balance between savings and investment in a
country.
D. claim that trade deficits are not determined by the external value of currency.
35. Exchange rates are _____ under a pure "free float" system.
A. completely balanced
B. determined by market forces
C. wildly variable and unpredictable
D. determined by the government
36. The great virtue claimed for a _____ is that it imposes monetary discipline on a country and leads to
low inflation.
A. fixed exchange rate

B. managed-float system
C. pegged exchange rate
D. floating exchange rate
37. _____ limits the ability of the government to print money and, thereby, create inflationary pressures.
A. A dirty-float system
B. A managed-float system
C. The European Monetary System
D. A currency board system
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Education.
38. Currencies of countries with currency boards will become uncompetitive and overvalued if:
A. local inflation rates remain higher than the inflation rate in the country to which the currency is
pegged.
B. the country to which the currency is pegged experiences a trade deficit.
C. local inflation rates are lower than the inflation rate in the country to which the currency is pegged.
D. the country to which the currency is pegged experiences a trade surplus.
39. A currency crisis occurs when:
A. investors lose confidence in a country's banking system.

B. a speculative attack on the exchange value of a currency results in a sharp depreciation in the value
of the currency.
C. authorities hoard large volumes of international currency reserves and sharply decrease interest
rates.
D. a speculative attack on the exchange value of a currency results in a sharp appreciation in the value
of the currency.
40. A _____ is a situation in which a country cannot service its foreign debt obligations.
A. currency crisis
B. banking crisis
C. foreign debt crisis
D. moral crisis
_____.
A. Japanese yen
B. local currencies
C. Chinese yuan
D. U.S. dollars
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Education.
42. Most of the loans issued by the IMF:
A. are conditional loans.

B. are unconditional loans.
C. include a macroeconomic policy that calls for lower interest rates.
D. include a macroeconomic policy that calls for increases in public spending to improve infrastructure
in a country.
43. The Asian economic crisis and the global financial of 2008-2009 crisis were caused by _____.
A. high inflation rates

B. excessive debt
C. low inflation rates
D. a huge trade surplus
44. It is difficult if not impossible to get adequate insurance coverage for exchange rates that:
A. will occur in the next few weeks.

B. might occur in the next few months.
C. might occur several years in the future.
D. are likely to occur in the coming days.
45. The international monetary system refers to the institutional arrangements that govern _____.
A. microeconomic parameters
B. exchange rates
C. gross domestic produce
D. foreign direct investment
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Education.
46. When the foreign exchange market determines the relative value of a currency, we say that the
country is adhering to a _____ regime.
A. currency board exchange

B. pegged exchange rate
C. fixed exchange rate
47. A pegged exchange rate means that the value of a currency is:
A. fixed against other currencies based on an agreement.

B. not determined by free market forces.
C. fixed relative to a reference currency.
D. independent of the valuations of other currencies.
48. A dirty float refers to a situation in which:
A. a set of currencies are fixed against each other at some mutually agreed on exchange rate.
B. many countries join hands to form a monetary system and an exchange rate.
C. more than one foreign currency is used as the formal reference for a country's currency.
D. a country tries to hold its currency against an important reference currency without a formal
pegged rate.
49. After World War II, the world's major industrial nations arranged their currencies against each other at
a mutually agreed on exchange rate. This is an example of a _____ system.

B. dirty float exchange
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Education.
50. Which of the following statements is true of the gold standard?
A. Gold standard was adopted only by the smaller nations of the world.
B. Currencies were pegged to gold under the gold standard.
C. Convertibility to gold was not guaranteed under the gold standard.
D. Gold standard was not helpful in maintaining balance-of-trade equilibrium.
51. Gold par value refers to the:
A. ratio of the price of gold in a currency to price of gold in U.S. dollars.

B. amount of a currency needed to purchase one ounce of gold.
C. ratio of price of gold in a currency to price of gold in euros.
D. amount of gold required to equal the reference currency that a nation is using.
A. it has the potential to produce all goods that its residents want without engaging in foreign trade.
B. the income its residents earn from exports is equal to the money its residents pay for imports.
C. the country import all goods that its residents want by engaging in foreign trade.
D. it has the potential to balance the production and procurement of the basic amenities that it needs.
53. A country's trade balance is in surplus when:
A. its exports are more than its imports.

B. it experiences negative inflation.
C. its exports equal the imports.
D. the prices of commodities are low in the country.
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54. Which of the following is an advantage of using the gold standard?
A. The standard makes sure that goods are not priced out from markets due to inflation.
B. The standard does not require a commitment from nations to maintain its currency's value.
C. The standard effectively prevents the devaluation of currencies across the world.
D. The standard contains a powerful mechanism for achieving balance-of-trade equilibrium by all
countries.
55. The agreement reached at Bretton Woods established the _____.
A. International Monetary Fund

B. World Economic Forum
C. United Nations
D. International Atomic Energy Agency
56. Which of the following observations is true of the Bretton Woods agreement?
A. All countries agreed to fix the value of their currency in terms of gold under the agreement.
B. The system accepted Pound as the official reference currency against gold.
C. The agreement established a floating system of monetary exchange.
D. Two multinational institutions, World Economic Forum and WTO, were formed under the
agreement.
57. The World Bank was established at the at Bretton Woods conference to:
A. establish an international monetary system.

B. promote general economic development.
C. establish gold standard across the world.
D. fund the initiatives of the United Nations.
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Education.
58. Identify the currency that was convertible to gold under the Bretton Woods system.
A. Pound
B. Yen
C. Euro
D. Dollar
59. What will happen if a country increases its money supply rapidly under fixed exchange rate regime?
A. Imports will become less attractive in that country.

B. The country will face negative inflation.
C. Trade deficit would widen in that country.
D. The country's products will become more attractive in world markets.
60. Which of the following is a disadvantage of using a rigid policy of fixed exchange rates?
A. It is likely to create high unemployment in some cases.

B. It will lead to inflationary economies across the world.
C. It is likely to bring about trade wars between nations.
D. It will instigate competitive devaluations and intense competition.
61. Which of the following is a function of World Bank?
A. Implementing a rigid fixed exchange rate regime

B. Promoting the gold standard across the world
C. Lending money to governments for development
D. Implementing a flexible fixed exchange rate regime
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Education.
62. Which of the following is a factor that initiated the collapse of the fixed exchange rate system?
A. Worsening of Great Britain's balance of trade

B. Recession in third world countries
C. Price inflation in Europe
D. Worsening of U.S. foreign trade position
63. Which of the following changes were made to the International Monetary Fund's Articles of
Agreement in the Jamaica agreement?
A. IMF members were permitted to use the U.S. dollar as the convertible currency.
B. Gold was declared as a formal reserve asset for IMF members.
C. IMF members were permitted to sell their gold reserves at the market price.
D. IMF members were restricted from entering the foreign exchange market.
64. _____ exchange rates were declared as acceptable in the Jamaica agreement of the International
Monetary Fund.
A. Pegged
B. Fixed
C. Floating
D. Gold standard
65. The United States had large and growing trade deficit between 1980 and 1985. Despite this, the value
of U.S. dollar rose during this period. Which of the following is a factor that caused this occurrence?
A. United States attracted heavy inflows of capital from foreign investors during this period.
B. Banks in the United States offered low interest rates to investors during this period.
C. Markets across the world witnessed strong economies during this period.
D. Developed countries in Europe maintained trade equilibrium and supplied goods to
underdeveloped countries.
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Education.
66. Which of the following is the reason why the current foreign-exchange system is sometimes thought
of as a managed-float system?
A. The exchange rates of a currency are determined by market forces.

B. Governments intervene frequently in the foreign exchange market.
C. Major currencies are allowed to freely float against each other.
D. Countries use a reference currency to estimate the value of their currencies.
67. Which of the following arguments is in favor of floating exchange rates?
A. A country's ability to expand or contract its money supply should be limited by the need to maintain
exchange rate parity.
B. Maintaining balance of trade equilibrium is not in the best interest of a country.
C. Countries can isolate themselves from uncertainties when they trade using a mutually agreed on
exchange rate.
D. Governments can restore monetary control by removing the obligation to maintain exchange rate
parity.
68. The monetary autonomy argument holds that:
A. each country should be allowed to choose its own inflation rate.

B. inflation is beneficial to a country's economy and growth.
C. inflation is detrimental to a country's economy and growth.
D. countries should restrict inflation based on the global standards.
69. Which of the following arguments is against the use of fixed exchange rates?
A. Monetary discipline is the most important determinant of a strong economy.

B. Each country has the freedom to choose its own inflation rate.
C. Market speculation can cause fluctuations in exchange rates.
D. Governments are likely to expand the monetary supply far too rapidly due to political pressures.
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Education.
70. Which of the following arguments strengthen the idea of floating exchange rates?
A. External agencies should not interfere in the monetary policies of a country.

B. Trade deficits can be corrected through changes in exchange rates.
C. Changes in exchange rates will not impact the trade balance in a country.
D. Governments should act in ways to minimize the uncertainty in monetary markets.
71. Those in favor of floating exchange rate claim that ____.
A. uncertainty in monetary markets dampens the growth of international trade

B. inflation is beneficial to a country if it is controlled closely
C. trade imbalances can be adjusted by using floating exchange rates
D. governments can have rigid control over monetary markets by using floating rates
72. Which of the following is an exchange rate policy where the exchange rate is determined completely
by market forces?
A. Managed float
B. Fixed peg
C. Free float
D. Currency board
73. Which of the following is the exchange rate policy where the government intervenes in the exchange
rate system only in a limited way?
A. Managed-float
B. Fixed peg
C. Free-float
D. Currency board
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Education.
74. Under a _____ exchange rate regime, a country will attach the value of its currency to that of a major
currency.
A. managed-float
B. pegged
C. free-float
D. currency board
75. Which of the following statements is true of pegged exchange rates?
A. A pegged exchange rate allows a country's currency to be determined by market forces.

B. A pegged exchange rate weakens the monetary discipline of a country.
C. Pegged exchange rates are popular among many of the world's smaller nations.
D. Adopting a pegged exchange rate regime increases inflationary pressures in a country.
demand into:
A. another currency at a fixed exchange rate.

B. gold or silver at a fixed exchange rate.
C. gold or silver at a floating exchange rate.
D. another currency at a floating exchange rate.
77. Under a currency board system:
A. inflation rates are maintained at high level.

B. countries issue domestic notes at will.
C. interest rates remain constant.
D. government lacks the ability to set interest rates.
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Education.
78. A currency crisis occurs due to:
A. the loss of confidence in a country's banking system.

B. heavy foreign debt obligations.
C. high levels of trade deficit.
D. a speculative attack on the exchange value.
79. Moral hazard arises when people behave recklessly because:
A. of the restrictions that exist in a country's monetary policy.

B. of the restrictions that IMF has imposed on them.
C. they know they will be saved if things go wrong.
D. they face financial difficulties arising out of external factors.
80. Which of the following is a common criticism against the International Monetary Fund?
A. IMF lacks any real mechanism for accountability.

B. It is hesitant to help banks when they are in crisis.
C. IMF has not intervened to resolve the Asian crisis.
D. It did not try to resolve the Mexican currency crisis.
81. Which of the following is a characteristic of a foreign debt crisis?
A. Narrowing current account deficit

B. Excessive expansion of domestic borrowing
C. Low relative price inflation rates
D. Asset price deflation
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Education.
82. Which of the following observations is true of the current system of the foreign exchange market?
A. Most of the currencies can be converted to gold in the current system of foreign exchange.
B. The current system is driven by fixed exchange rates.
C. Currencies float freely against others in the current system.
D. The current system is a combination of government intervention and speculative activity.
83. Which of the following will help a company hedge against currency fluctuations?
A. Finding a large supplier to supply all the raw materials

B. In-house manufacturing of raw materials
C. Basing business in a single country
D. Dispersing production to different geographic locations
84. Contracting out manufacturing allows companies to reduce economic exposure because:
A. having multiple suppliers attracts subsidies from government.

B. it reduces the pressure on them to maintain a trade surplus.
C. it allows companies to shift suppliers from country to country.
D. quality issues are insignificant when manufacturing is contracted to others.
85. Increasingly the _____ has been acting as macroeconomic police of the world economy, insisting that
countries seeking significant borrowings adopt certain macroeconomic policies.
A. Economic and Social Council (ECOSOC)

B. International Monetary Fund (IMF)
C. United Nations (UN)
D. World Bank
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Education.
86. Countries that require substantial loans from the International Monetary Fund to survive will _____ due
to IMF-mandated economic policies.
A. benefit from a sharp expansion of demand in the long term

B. endure a sharp contraction of demand in the long term
C. benefit from a sharp expansion of demand in the short term
D. endure a sharp contraction of demand in the short term
87. In the face of unpredictable movements in exchange rates, businesses should:
A. pursue strategies that will reduce their economic exposure.

B. pursue strategies that will reduce the company's strategic exposure.
C. pursue strategies that will reduce their foreign market exposure.
D. sell off investments in foreign subsidiaries and consolidate domestic facilities.
88. The world's four major trading currencies, the Japanese yen, the U.S. dollar, the British pound, and the
European Union's euro are all free to float against each other. What is this an example of?
A. pegged exchange rate regime

B. floating exchange rate regime
C. managed-float system
D. fixed exchange rate regime
89. Prior to the introduction of the euro, many EU countries participated in a _____.
A. floating exchange rate system

B. currency board system
C. fixed exchange rate system
D. pegged exchange rate system
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Education.
90. _____ are popular among many of the world's smaller nations.
A. Floating exchange rates

B. Full fixed exchange rates
C. Fixed exchange rates
D. Pegged exchange rates
91. The International Monetary Fund has been criticized for exacerbating moral hazard:
A. with its rescue programs.

B. by increasing the probability of debt default.
C. making loans to countries that are trying to reduce national debt by "playing the market."
D. by refusing to bail out banks that made loans to overleveraged Asian companies during the 1990s.
92. A _____ 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. currency crisis
B. banking crisis
D. domestic debt crisis
Essay Questions
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Education.
93. What is international monetary system? What are the major trading currencies?
94. Compare and contrast a pegged exchange system with a dirty-float system of exchange rates.
95. What is gold standard? What was the major advantage of the system?
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Education.
96. With the help of an example, explain how balance-of-trade equilibrium is maintained under the gold
standard.
97. What is the Bretton Woods agreement? How was it different from the gold standard?
98. Identify the multinational institutions that were established at the Bretton Woods agreement. What
were their roles in the international monetary system?
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Education.
99. Explain the events that led to the failure of the Bretton Woods system.
100. Discuss the significance of the Jamaica Agreement.
101. Discuss the arguments that favor a floating exchange rate system against a fixed exchange rate
system.
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Education.
102. Present the common arguments that favor fixed exchange rates.
103. Describe the different exchange rate policies that are in practice today.
104. What is a currency board? Why do countries choose this type of system? What are the disadvantages
of this type of arrangement?
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Education.
105. Recent policies of the International Monetary Fund have drawn a lot of criticism. Discuss these
criticisms.
106. How can international companies reduce their economic exposure in a world of constantly fluctuating
exchange rates?
107. Do you think businesses can influence government policies? Explain your answer.
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Education.
Chapter 11 The International Monetary System Answer Key
True / False Questions
1. The international monetary system refers to the institutional arrangements that govern exchange
rates.
TRUE
The international monetary system refers to the institutional arrangements that govern exchange
rates.
AACSB: Analytical Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 11-01 Describe the historical development of the modern global monetary system.
Topic: Introduction
2. The gold standard called for fixed exchange rates against the U.S. dollar.
FALSE
Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. By 1880,
most of the world's major trading nations, including Great Britain, Germany, Japan, and the United
States, had adopted the gold standard.
AACSB: Knowledge Application

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
Topic: The History of the Global Monetary System
11-27
Education.
3. The agreement reached at Bretton Woods established the International Monetary Fund (IMF) and
the World Bank.
TRUE
The agreement reached at Bretton Woods established two multinational institutions—the

International Monetary Fund (IMF) and the World Bank.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 11-02 Explain the role played by the World Bank and the IMF in the international monetary system.
Topic: The Role of the World Bank and the International Monetary Fund in the International Monetary System
4. Implementing a fixed exchange rate regime increases the price inflation in countries.
FALSE
A fixed exchange rate regime imposes monetary discipline on countries, thereby curtailing price
inflation.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
5. World Bank offers low-interest loans to risky customers whose credit rating is often poor.
TRUE
World Bank offers low-interest loans to risky customers whose credit rating is often poor, such as
the governments of underdeveloped nations.
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Education.
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
6. The fixed exchange rate system established at Bretton Woods failed due to speculative pressures
on the U.S. dollar.
TRUE
U.S. dollar was the only currency that could be converted into gold in the fixed exchange rate
system established at Bretton Woods. As the currency that served as the reference point for all
others, the dollar occupied a central place in the system. The system failed when its key currency
U.S. dollar faced speculative pressure.

Blooms: Understand
Difficulty: 2 Medium
Gradable: automatic
7. Gold was declared as the formal reserve asset in the Jamaica agreement of 1976.
FALSE
In the Jamaica agreement, gold was abandoned as a reserve asset. The IMF returned its gold
reserves to members at the current market price, placing the proceeds in a trust fund to help poor
nations.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
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Education.
8. Market forces have produced a stable dollar exchange rate under a floating exchange rate regime.
FALSE
Under a floating exchange rate regime, market forces have produced a volatile dollar exchange
rate. Governments have sometimes responded by intervening in the market—buying and selling
dollars—in an attempt to limit the market's volatility and to correct what they see as overvaluation
or potential undervaluation of the dollar.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
9. Fixed exchange rates lead to speculation and uncertainty in the value of currencies.
FALSE
Speculation can make exchange rates volatile in the floating exchange rate system. Speculation also
adds to the uncertainty surrounding future currency movements that characterizes floating
exchange rate regimes. A fixed exchange rate eliminates such uncertainty.

Blooms: Understand
Gradable: automatic
Learning Objective: 11-03 Compare and contrast the differences between a fixed and a floating exchange rate system.
Topic: Fixed versus Floating Exchange Rate Systems
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Education.
10. Adopting a pegged exchange rate regime increases the inflationary pressures in a country.
FALSE
Evidence shows that adopting a pegged exchange rate regime moderates inflationary pressures in
a country.

Blooms: Understand
Gradable: automatic
Learning Objective: 11-04 Identify exchange rate regimes used in the world today and why countries adopt different exchange rate
regimes.
Topic: Different Exchange Rate Regimes
demand into another currency at a fixed exchange rate.
TRUE
A country that introduces a currency board commits itself to converting its domestic currency on
demand into another currency at a fixed exchange rate. To make this commitment credible, the
currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100
percent of the domestic currency issued.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
regimes.
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Education.
12. Interest rates adjust automatically under a strict currency board system.
TRUE
Under a strict currency board system, interest rates adjust automatically. If investors want to switch
out of domestic currency into, for example, U.S. dollars, the supply of domestic currency will shrink.
This will cause interest rates to rise until it eventually becomes attractive for investors to hold the
local currency again.

Blooms: Understand
Gradable: automatic
regimes.
13. The International Monetary Fund's original function was to provide a pool of money from which
members could borrow in the short term.
TRUE
The IMF's original function was to provide a pool of money from which members could borrow,
short term, to adjust their balance-of-payments position and maintain their exchange rate.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 11-05 Understand the debate surrounding the role of the IMF in the management of financial crises.
11-32
Education.
14. The International Monetary Fund made pegging the Mexican peso to the dollar, a condition for
lending money to the Mexican government in the 1980s.
TRUE
The Mexican peso had been pegged to the dollar since the early 1980s when the International
Monetary Fund made it a condition for lending money to the Mexican government.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
15. Government projects were a factor behind the investment boom in most Southeast Asian
economies.
TRUE
An added factor behind the investment boom in most Southeast Asian economies was the
government. In many cases, the governments had embarked on huge infrastructure projects.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-33
Education.
16. The quality of investments declined significantly in the Asian countries during the 1990s.
TRUE
Volume of investments increased in the Asian countries during the 1990s. As the volume of
investments ballooned, often at the bequest of national governments, the quality of many of these
investments declined significantly.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
local currencies.
FALSE
The companies that had made the investments in Asia, in 1990s, were under huge debt burdens
and they were finding it difficult to service. Much of the borrowing had been in U.S. dollars, as
opposed to local currencies.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Topic: Crisis Management by the IMF
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Education.
18. Moral hazard arises when people behave recklessly because they know they will be saved if things
go wrong.
TRUE
Moral hazard arises when people behave recklessly because they know they will be saved if things
go wrong.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
19. The current system of foreign exchange is a mixed system of government intervention and
speculative activity.
TRUE
The current system of foreign exchange is a mixed system in which a combination of government
intervention and speculative activity can drive the foreign exchange market.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 11-06 Explain the implications of the global monetary system for currency management and business strategy.
Topic: Currency Management and Business Strategy in the Global Monetary System
11-35
Education.
20. Firms should not utilize the forward exchange market when they are faced with uncertainty about
the future value of currencies.
FALSE
Faced with uncertainty about the future value of currencies, firms can utilize the forward exchange
market.

Blooms: Understand
Gradable: automatic
21. An effective business strategy to reduce economic exposure is to contract out high value-added
manufacturing.
FALSE
Another way of building strategic flexibility and reducing economic exposure involves contracting
out manufacturing. This allows a company to shift suppliers from country to country. However, this
kind of strategy may work only for low value-added manufacturing (e.g., textiles) in which the
individual manufacturers have few if any firm-specific skills that contribute to the value of the
product.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
Multiple Choice Questions
11-36
Education.
22. The _____ refers to the institutional arrangements that govern exchange rates.
A. World Bank
B. international monetary system
C. currency exchange
D. gold standard
rates.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Topic: Introduction
23. A _____ means the value of a currency is fixed relative to a reference currency.
A. pegged exchange rate

B. floating exchange rate
C. managed float system
D. fixed exchange rate
A pegged exchange rate means the value of the currency is fixed relative to a reference currency,
such as the U.S. dollar, and then the exchange rate between that currency and other currencies is
determined by the reference currency exchange rate.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-37
Education.
24. When a country tries to hold the value of their currency within some range against an important
reference currency such as the U.S. dollar without adopting a formal pegged rate, it is referred to as
a _____.
A. gold standard
B. pegged float
C. dirty float
D. currency peg
Countries, while not adopting a formal pegged rate, try to hold the value of their currency within
some range against an important reference currency such as the U.S. dollar, or a "basket" of
currencies. This is often referred to as a dirty float.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
25. The amount of a currency needed to purchase one ounce of gold was referred to as the _____.
A. golden rule
B. gold standard
C. pegged gold value
D. gold par value
Under the gold standard, the amount of a currency needed to purchase one ounce of gold was
referred to as the gold par value.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-38
Education.
A. the income its residents earn from exports is equal to the money its residents pay to other
countries for imports.
B. it produces all the goods needed for domestic consumption.
C. the income its residents earn from imports is equal to the money its residents pay to other
countries for exports.
D. it produces all the goods needed for exportation.
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 other countries for imports (the current account
of its balance of payments is in balance).

Blooms: Apply
Gradable: automatic
27. Under a pegged exchange rate regime, a country:
A. commits itself to converting its domestic currency on demand into another currency at a fixed
exchange rate.
B. will peg the value of its currency to that of a major currency.
C. valuates its currency without attaching it to a reference currency.
D. follows the foreign exchange market to determine the relative value of a currency.
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 U.S. dollar rises in value, its own currency rises too.

Blooms: Apply
11-39
Education.
Gradable: automatic
regimes.
28. International Development Association loans:
A. receive direct funding from the World Bank.

B. must be countersigned by a partnering, wealthy country such as the United States, Japan, or
Germany.
C. are funded through subscriptions from wealthy members.
D. receive direct funding from the International Monetary Fund.
One of the funding schemes of the World Bank 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.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
29. International Monetary Fund members were _____ in the Jamaica agreement.
A. not permitted to sell their own gold reserves

B. permitted to sell their own gold reserves, but only at the price set by IMF
C. required to hold their gold reserves in escrow
D. permitted to sell their own gold reserves at the market price
In the Jamaica agreement, gold was abandoned as a reserve asset. IMF also permitted its members
to sell their own gold reserves at the market price.
11-40
Education.
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
30. The value of U.S dollar increased between 1980 and 1985:
A. despite running a growing trade deficit.

B. despite exporting substantially more that it imported.
C. because of a growing trade surplus.
D. because the country's status as a world financial leader was becoming apparent.
The rise in the value of the dollar between 1980 and 1985 occurred when the United States was
running a large and growing trade deficit, importing substantially more than it exported. A number
of favorable factors overcame the unfavorable effect of a trade deficit.
AACSB: Reflective Thinking

Blooms: Apply
Gradable: automatic
31. The rise in the value of the dollar between 1985 and 1988:
A. gave U.S goods a competitive advantage over others.

B. made imports relatively cheap.
C. gave U.S. goods a comparative advantage over others.
D. made imports expensive.
Rise in dollar will make U.S. goods less competitive. The rise in the dollar priced U.S. goods out of
foreign markets and made imports relatively cheap.
11-41
Education.
Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
32. Advocates of a _____ argue that removal of the obligation to maintain exchange rate parity would
restore monetary control to a government.
A. fixed exchange rate regime

B. dirty-float system
C. floating exchange rate regime
D. pegged exchange rate regime
Advocates of a floating exchange rate regime argue that removal of the obligation to maintain
exchange rate parity would restore monetary control to a government.

Blooms: Apply
Gradable: automatic
33. The monetary autonomy argument is supported by the advocates of _____.
A. a dirty-float system
B. fixed exchange rates
C. pegged exchange rates
D. floating exchange rates
Advocates of floating rates argue that each country should be allowed to choose its own inflation
rate. This is called the monetary autonomy argument. Advocates of fixed rates argue against this.
11-42
Education.
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
34. Supporters of floating exchange rates:
A. argue that floating rates help adjust trade imbalances.

B. argue that floating rates lead to a more stable world monetary system.
C. claim that trade deficits are determined by the balance between savings and investment in a
country.
D. claim that trade deficits are not determined by the external value of currency.
Those in favor of floating exchange rates argue that floating rates help adjust trade imbalances.
Critics of floating rates claim that trade deficits are determined by the balance between savings and
investment in a country, not by the external value of its currency.

Blooms: Apply
Gradable: automatic
35. Exchange rates are _____ under a pure "free float" system.
A. completely balanced
B. determined by market forces
C. wildly variable and unpredictable
D. determined by the government
Under a pure "free float" system, exchange rates are determined by market forces.
11-43
Education.
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
regimes.
36. The great virtue claimed for a _____ is that it imposes monetary discipline on a country and leads to
low inflation.

B. managed-float system
As with a full fixed exchange rate regime, the great virtue claimed for a pegged exchange rate is
that it imposes monetary discipline on a country and leads to low inflation.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
regimes.
11-44
Education.
37. _____ limits the ability of the government to print money and, thereby, create inflationary pressures.
A. A dirty-float system
B. A managed-float system
C. The European Monetary System
D. A currency board system
The currency board can issue additional domestic notes and coins only when there are foreign
exchange reserves to back it. This limits the ability of the government to print money and, thereby,
create inflationary pressures.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
regimes.
38. Currencies of countries with currency boards will become uncompetitive and overvalued if:
A. local inflation rates remain higher than the inflation rate in the country to which the currency is
pegged.
B. the country to which the currency is pegged experiences a trade deficit.
C. local inflation rates are lower than the inflation rate in the country to which the currency is
pegged.
D. the country to which the currency is pegged experiences a trade surplus.
If local inflation rates remain higher than the inflation rate in the country to which the currency is
pegged, the currencies of countries with currency boards can become uncompetitive and
overvalued.

Blooms: Apply
11-45
Education.
Gradable: automatic
regimes.
39. A currency crisis occurs when:
A. investors lose confidence in a country's banking system.

B. a speculative attack on the exchange value of a currency results in a sharp depreciation in the
value of the currency.
C. authorities hoard large volumes of international currency reserves and sharply decrease interest
rates.
D. a speculative attack on the exchange value of a currency results in a sharp appreciation in the
value of the currency.
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.

Blooms: Apply
Gradable: automatic
11-46
Education.
40. A _____ is a situation in which a country cannot service its foreign debt obligations.
A. currency crisis
B. banking crisis
D. moral crisis
A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations,
whether private-sector or government debt.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
_____.
A. Japanese yen
B. local currencies
C. Chinese yuan
D. U.S. dollars
The companies that had made the investments in Asia, in 1990s, were under huge debt burdens
and they were finding it difficult to service. Much of the borrowing had been in U.S. dollars, as
opposed to local currencies.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Topic: Crisis Management by the IMF
11-47
Education.
42. Most of the loans issued by the IMF:
A. are conditional loans.

B. are unconditional loans.
C. include a macroeconomic policy that calls for lower interest rates.
D. include a macroeconomic policy that calls for increases in public spending to improve
infrastructure in a country.
All IMF loan packages come with conditions attached. Until very recently, the IMF has insisted on a
combination of tight macroeconomic policies, including cuts in public spending, higher interest
rates, and tight monetary policy.

Blooms: Apply
Gradable: automatic
43. The Asian economic crisis and the global financial of 2008-2009 crisis were caused by _____.
A. high inflation rates

B. excessive debt
C. low inflation rates
D. a huge trade surplus
The Asian economic crisis and the global financial of 2008-2009 crisis were caused not by high
inflation rates, but by excessive debt.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-48
Education.
44. It is difficult if not impossible to get adequate insurance coverage for exchange rates that:
A. will occur in the next few weeks.

B. might occur in the next few months.
C. might occur several years in the future.
D. are likely to occur in the coming days.
It is difficult if not impossible to get adequate insurance coverage for exchange rates that might
occur several years in the future. The forward market tends to offer coverage for exchange rate
changes a few months—not years—ahead.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
45. The international monetary system refers to the institutional arrangements that govern _____.
A. microeconomic parameters
B. exchange rates
C. gross domestic produce
D. foreign direct investment
rates.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-49
Education.
46. When the foreign exchange market determines the relative value of a currency, we say that the
country is adhering to a _____ regime.
A. currency board exchange

B. pegged exchange rate
C. fixed exchange rate
When the foreign exchange market determines the relative value of a currency, we say that the
country is adhering to a floating exchange rate regime. Four of the world's major trading
currencies—the U.S. dollar, the European Union's euro, the Japanese yen, and the British pound—
are all free to float against each other.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
47. A pegged exchange rate means that the value of a currency is:
A. fixed against other currencies based on an agreement.

B. not determined by free market forces.
C. fixed relative to a reference currency.
D. independent of the valuations of other currencies.
determined by the reference currency exchange rate.

Blooms: Remember
11-50
Education.
Difficulty: 1 Easy
Gradable: automatic
48. A dirty float refers to a situation in which:
A. a set of currencies are fixed against each other at some mutually agreed on exchange rate.
B. many countries join hands to form a monetary system and an exchange rate.
C. more than one foreign currency is used as the formal reference for a country's currency.
D. a country tries to hold its currency against an important reference currency without a formal
pegged rate.
Countries, while not adopting a formal pegged rate, try to hold the value of their currency within
some range against an important reference currency such as the U.S. dollar, or a "basket" of
currencies. This is often referred to as a dirty float.

Blooms: Apply
Gradable: automatic
49. After World War II, the world's major industrial nations arranged their currencies against each other
at a mutually agreed on exchange rate. This is an example of a _____ system.

B. dirty float exchange
With a fixed exchange rate system, the values of a set of currencies are fixed against each other at
some mutually agreed on exchange rate.
11-51
Education.
Blooms: Apply
Gradable: automatic
50. Which of the following statements is true of the gold standard?
A. Gold standard was adopted only by the smaller nations of the world.
B. Currencies were pegged to gold under the gold standard.
C. Convertibility to gold was not guaranteed under the gold standard.
D. Gold standard was not helpful in maintaining balance-of-trade equilibrium.
States, had adopted the gold standard.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
51. Gold par value refers to the:
A. ratio of the price of gold in a currency to price of gold in U.S. dollars.

B. amount of a currency needed to purchase one ounce of gold.
C. ratio of price of gold in a currency to price of gold in euros.
D. amount of gold required to equal the reference currency that a nation is using.
The amount of a currency needed to purchase one ounce of gold is referred to as the gold par
value.
11-52
Education.
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
A. it has the potential to produce all goods that its residents want without engaging in foreign
trade.
B. the income its residents earn from exports is equal to the money its residents pay for imports.
C. the country import all goods that its residents want by engaging in foreign trade.
D. it has the potential to balance the production and procurement of the basic amenities that it
needs.
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 other countries for imports (the current account
of its balance of payments is in balance).

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
11-53
Education.
53. A country's trade balance is in surplus when:
A. its exports are more than its imports.

B. it experiences negative inflation.
C. its exports equal the imports.
D. the prices of commodities are low in the country.
A country's trade balance is in surplus when it exports more than what it imports.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
54. Which of the following is an advantage of using the gold standard?
A. The standard makes sure that goods are not priced out from markets due to inflation.
B. The standard does not require a commitment from nations to maintain its currency's value.
C. The standard effectively prevents the devaluation of currencies across the world.
D. The standard contains a powerful mechanism for achieving balance-of-trade equilibrium by all
countries.
The great strength claimed for the gold standard was that it contained a powerful mechanism for
achieving balance-of-trade equilibrium by all countries.

Blooms: Analyze
Gradable: automatic
11-54
Education.
55. The agreement reached at Bretton Woods established the _____.
A. International Monetary Fund

B. World Economic Forum
C. United Nations
D. International Atomic Energy Agency
The agreement reached at Bretton Woods established two multinational institutions—the

International Monetary Fund (IMF) and the World Bank.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
56. Which of the following observations is true of the Bretton Woods agreement?
A. All countries agreed to fix the value of their currency in terms of gold under the agreement.
B. The system accepted Pound as the official reference currency against gold.
C. The agreement established a floating system of monetary exchange.
D. Two multinational institutions, World Economic Forum and WTO, were formed under the
agreement.
The Bretton Woods agreement called for a system of fixed exchange rates that would be policed by
the IMF. Under the agreement, all countries were to fix the value of their currency in terms of gold
but were not required to exchange their currencies for gold.

Blooms: Analyze
Gradable: automatic
11-55
Education.
57. The World Bank was established at the at Bretton Woods conference to:
A. establish an international monetary system.

B. promote general economic development.
C. establish gold standard across the world.
D. fund the initiatives of the United Nations.
The agreement reached at Bretton Woods established the World Bank. The task of the World Bank
was to promote general economic development.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
58. Identify the currency that was convertible to gold under the Bretton Woods system.
A. Pound
B. Yen
C. Euro
D. Dollar
Under the Bretton Woods agreement, 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 dollar remained
convertible into gold.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-56
Education.
59. What will happen if a country increases its money supply rapidly under fixed exchange rate
regime?
A. Imports will become less attractive in that country.

B. The country will face negative inflation.
C. Trade deficit would widen in that country.
D. The country's products will become more attractive in world markets.
A fixed exchange rate regime imposes monetary discipline on countries and curtails price inflation.
For example, if a country increases its money supply by printing more currency, the increase in
money supply would lead to price inflation. Given fixed exchange rates, inflation would make the
country's goods uncompetitive in world markets, while the prices of imports would become more
attractive in that country. The result would be a widening trade deficit in the country, with the
country importing more than it exports.

Blooms: Analyze
Gradable: automatic
60. Which of the following is a disadvantage of using a rigid policy of fixed exchange rates?
A. It is likely to create high unemployment in some cases.

B. It will lead to inflationary economies across the world.
C. It is likely to bring about trade wars between nations.
D. It will instigate competitive devaluations and intense competition.
A rigid policy of fixed exchange rates would be too inflexible. In some cases, a country's attempts to
reduce its money supply growth and correct a persistent balance-of-payments deficit could force
the country into recession and create high unemployment.
11-57
Education.
Blooms: Apply
Gradable: automatic
61. Which of the following is a function of World Bank?
A. Implementing a rigid fixed exchange rate regime

B. Promoting the gold standard across the world
C. Lending money to governments for development
D. Implementing a flexible fixed exchange rate regime
The World Bank was established to reconstruct world economies. The bank lends money to entities
such as governments.

Blooms: Remember
Gradable: automatic
11-58
Education.
62. Which of the following is a factor that initiated the collapse of the fixed exchange rate system?
A. Worsening of Great Britain's balance of trade

B. Recession in third world countries
C. Price inflation in Europe
D. Worsening of U.S. foreign trade position
U.S. dollar had a special role in the fixed exchange rate system as the only currency that could be
converted into gold. This meant that any pressure on the dollar would devalue the system. The
increase in inflation and the worsening of the U.S. foreign trade position gave rise to speculation in
the foreign exchange market that the dollar would be devalued. This initiated the demise of the
fixed exchange rate system.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
63. Which of the following changes were made to the International Monetary Fund's Articles of
Agreement in the Jamaica agreement?
A. IMF members were permitted to use the U.S. dollar as the convertible currency.
B. Gold was declared as a formal reserve asset for IMF members.
C. IMF members were permitted to sell their gold reserves at the market price.
D. IMF members were restricted from entering the foreign exchange market.
IMF members met in Jamaica in January 1976 and agreed to the rules for the international
monetary system that are in place today. In the meeting, gold was abandoned as a reserve asset.
IMF members were permitted to sell their own gold reserves at the market price.

Blooms: Understand
11-59
Education.
Difficulty: 1 Easy
Gradable: automatic
64. _____ exchange rates were declared as acceptable in the Jamaica agreement of the International
Monetary Fund.
A. Pegged
B. Fixed
C. Floating
D. Gold standard
Floating rates were declared acceptable in the Jamaica agreement. IMF members were also
permitted to enter the foreign exchange market to even out "unwarranted" speculative fluctuations.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-60
Education.
65. The United States had large and growing trade deficit between 1980 and 1985. Despite this, the
value of U.S. dollar rose during this period. Which of the following is a factor that caused this
occurrence?
A. United States attracted heavy inflows of capital from foreign investors during this period.
B. Banks in the United States offered low interest rates to investors during this period.
C. Markets across the world witnessed strong economies during this period.
D. Developed countries in Europe maintained trade equilibrium and supplied goods to
underdeveloped countries.
A number of favorable factors overcame the unfavorable effect of a trade deficit. Strong economic
growth in the United States was one such factor. It attracted heavy inflows of capital from foreign
investors seeking high returns on capital assets.

Blooms: Apply
Gradable: automatic
66. Which of the following is the reason why the current foreign-exchange system is sometimes
thought of as a managed-float system?
A. The exchange rates of a currency are determined by market forces.

B. Governments intervene frequently in the foreign exchange market.
C. Major currencies are allowed to freely float against each other.
D. Countries use a reference currency to estimate the value of their currencies.
High frequency of government intervention in the foreign exchange market explains why the
current system is sometimes thought of as a managed-float system or a dirty-float system.

Blooms: Apply
11-61
Education.
Gradable: automatic
67. Which of the following arguments is in favor of floating exchange rates?
A. A country's ability to expand or contract its money supply should be limited by the need to
maintain exchange rate parity.
B. Maintaining balance of trade equilibrium is not in the best interest of a country.
C. Countries can isolate themselves from uncertainties when they trade using a mutually agreed
on exchange rate.
D. Governments can restore monetary control by removing the obligation to maintain exchange
rate parity.
Advocates of a floating exchange rate regime argue that removal of the obligation to maintain
exchange rate parity would restore monetary control to a government. If a government faced with
unemployment wanted to increase its money supply to stimulate domestic demand and reduce
unemployment, it could do so unencumbered by the need to maintain its exchange rate.

Blooms: Analyze
Gradable: automatic
11-62
Education.
68. The monetary autonomy argument holds that:
A. each country should be allowed to choose its own inflation rate.

B. inflation is beneficial to a country's economy and growth.
C. inflation is detrimental to a country's economy and growth.
D. countries should restrict inflation based on the global standards.
rate. This is called the monetary autonomy argument.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
69. Which of the following arguments is against the use of fixed exchange rates?
A. Monetary discipline is the most important determinant of a strong economy.

B. Each country has the freedom to choose its own inflation rate.
C. Market speculation can cause fluctuations in exchange rates.
D. Governments are likely to expand the monetary supply far too rapidly due to political pressures.
rate. This is called the monetary autonomy argument.

Blooms: Analyze
Gradable: automatic
11-63
Education.
70. Which of the following arguments strengthen the idea of floating exchange rates?
A. External agencies should not interfere in the monetary policies of a country.

B. Trade deficits can be corrected through changes in exchange rates.
C. Changes in exchange rates will not impact the trade balance in a country.
D. Governments should act in ways to minimize the uncertainty in monetary markets.
The supporters of floating exchange rates argue that floating rates can correct trade deficit by
making its exports cheaper and its imports more expensive. They argue that exchange rate
depreciation should correct the trade deficit.

Blooms: Analyze
Gradable: automatic
71. Those in favor of floating exchange rate claim that ____.
A. uncertainty in monetary markets dampens the growth of international trade

B. inflation is beneficial to a country if it is controlled closely
C. trade imbalances can be adjusted by using floating exchange rates
D. governments can have rigid control over monetary markets by using floating rates
Those in favor of floating exchange rates argue that floating rates help adjust trade imbalances.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
11-64
Education.
72. Which of the following is an exchange rate policy where the exchange rate is determined
completely by market forces?
A. Managed float
B. Fixed peg
C. Free float
D. Currency board
Governments around the world pursue a number of different exchange rate policies. One such
policy is a pure "free float" where the exchange rate is determined by market forces.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
regimes.
73. Which of the following is the exchange rate policy where the government intervenes in the
exchange rate system only in a limited way?
A. Managed-float
B. Fixed peg
C. Free-float
D. Currency board
In a managed-float system governments intervene in only a limited way. About 26 percent of IMF's
members use this system.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
11-65
Education.
regimes.
74. Under a _____ exchange rate regime, a country will attach the value of its currency to that of a
major currency.
A. managed-float
B. pegged
C. free-float
D. currency board
Under a pegged exchange rate regime, a country will attach the value of its currency to that of a

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
regimes.
75. Which of the following statements is true of pegged exchange rates?
A. A pegged exchange rate allows a country's currency to be determined by market forces.

B. A pegged exchange rate weakens the monetary discipline of a country.
C. Pegged exchange rates are popular among many of the world's smaller nations.
D. Adopting a pegged exchange rate regime increases inflationary pressures in a country.
major currency. Pegged exchange rates are popular among many of the world's smaller nations.

Blooms: Remember
Difficulty: 1 Easy
11-66
Education.
Gradable: automatic
regimes.
demand into:
A. another currency at a fixed exchange rate.

B. gold or silver at a fixed exchange rate.
C. gold or silver at a floating exchange rate.
D. another currency at a floating exchange rate.
demand into another currency at a fixed exchange rate. To make this commitment credible, the
percent of the domestic currency issued.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
regimes.
11-67
Education.
77. Under a currency board system:
A. inflation rates are maintained at high level.

B. countries issue domestic notes at will.
C. interest rates remain constant.
D. government lacks the ability to set interest rates.
Under a currency board system, government lacks the ability to set interest rates. Interest rates in
Hong Kong, for example, are effectively set by the U.S. Federal Reserve.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
regimes.
78. A currency crisis occurs due to:
A. the loss of confidence in a country's banking system.

B. heavy foreign debt obligations.
C. high levels of trade deficit.
D. a speculative attack on the exchange value.
exchange rate.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
11-68
Education.
79. Moral hazard arises when people behave recklessly because:
A. of the restrictions that exist in a country's monetary policy.

B. of the restrictions that IMF has imposed on them.
C. they know they will be saved if things go wrong.
D. they face financial difficulties arising out of external factors.
go wrong.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
80. Which of the following is a common criticism against the International Monetary Fund?
A. IMF lacks any real mechanism for accountability.

B. It is hesitant to help banks when they are in crisis.
C. IMF has not intervened to resolve the Asian crisis.
D. It did not try to resolve the Mexican currency crisis.
One criticism of the IMF is that it has become too powerful for an institution that lacks any real
mechanism for accountability.

Blooms: Understand
Difficulty: 1 Easy
Gradable: automatic
11-69
Education.
81. Which of the following is a characteristic of a foreign debt crisis?
A. Narrowing current account deficit

B. Excessive expansion of domestic borrowing
C. Low relative price inflation rates
D. Asset price deflation
Foreign debt crises tend to have common underlying macroeconomic causes: high relative price
inflation rates, a widening current account deficit, excessive expansion of domestic borrowing, high
government deficits, and asset price inflation (such as sharp increases in stock and property prices).

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
82. Which of the following observations is true of the current system of the foreign exchange market?
A. Most of the currencies can be converted to gold in the current system of foreign exchange.
B. The current system is driven by fixed exchange rates.
C. Currencies float freely against others in the current system.
D. The current system is a combination of government intervention and speculative activity.
The current system of foreign exchange is a mixed system in which a combination of government
intervention and speculative activity can drive the foreign exchange market.

Blooms: Analyze
Gradable: automatic
11-70
Education.
83. Which of the following will help a company hedge against currency fluctuations?
A. Finding a large supplier to supply all the raw materials

B. In-house manufacturing of raw materials
C. Basing business in a single country
D. Dispersing production to different geographic locations
Maintaining strategic flexibility can take the form of dispersing production to different locations
around the globe as a real hedge against currency fluctuations.

Blooms: Apply
Gradable: automatic
84. Contracting out manufacturing allows companies to reduce economic exposure because:
A. having multiple suppliers attracts subsidies from government.

B. it reduces the pressure on them to maintain a trade surplus.
C. it allows companies to shift suppliers from country to country.
D. quality issues are insignificant when manufacturing is contracted to others.
One way of building strategic flexibility and reducing economic exposure involves contracting out
manufacturing. This allows a company to shift suppliers from country to country in response to
changes in relative costs brought about by exchange rate movements.

Blooms: Apply
Gradable: automatic
11-71
Education.
85. Increasingly the _____ has been acting as macroeconomic police of the world economy, insisting
that countries seeking significant borrowings adopt certain macroeconomic policies.
A. Economic and Social Council (ECOSOC)

B. International Monetary Fund (IMF)
C. United Nations (UN)
D. World Bank
Increasingly the IMF has been acting as macroeconomic police of the world economy, insisting that
countries seeking significant borrowings adopt IMF-mandated macroeconomic policies.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
86. Countries that require substantial loans from the International Monetary Fund to survive will _____
due to IMF-mandated economic policies.
A. benefit from a sharp expansion of demand in the long term

B. endure a sharp contraction of demand in the long term
C. benefit from a sharp expansion of demand in the short term
D. endure a sharp contraction of demand in the short term
Increasingly, the IMF has been acting as the macroeconomic police of the world economy, insisting
that countries seeking significant borrowings adopt IMF-mandated macroeconomic policies. These
policies typically include anti-inflationary monetary policies and reductions in government
spending. In the short run, such policies usually result in a sharp contraction of demand.

Blooms: Apply
Gradable: automatic
11-72
Education.
87. In the face of unpredictable movements in exchange rates, businesses should:
A. pursue strategies that will reduce their economic exposure.

B. pursue strategies that will reduce the company's strategic exposure.
C. pursue strategies that will reduce their foreign market exposure.
D. sell off investments in foreign subsidiaries and consolidate domestic facilities.
It makes sense for businesses to pursue strategies that will increase the company's strategic
flexibility in the face of unpredictable exchange rate movements—that is, to pursue strategies that
reduce the economic exposure of the firm.

Blooms: Apply
Gradable: automatic
11-73
Education.
88. The world's four major trading currencies, the Japanese yen, the U.S. dollar, the British pound, and
the European Union's euro are all free to float against each other. What is this an example of?
A. pegged exchange rate regime

B. floating exchange rate regime
C. managed-float system
D. fixed exchange rate regime
When the foreign exchange market determines the relative value of a currency, the country is
adhering to a floating exchange rate system. The world's four major trading currencies, the
Japanese yen, the U.S. dollar, the British pound, and the European Union's euro are all free to float
against each other. Consequently, their exchange rates are determined by market forces and
fluctuate against each other daily.

Blooms: Apply
Gradable: automatic
Topic: Introduction
89. Prior to the introduction of the euro, many EU countries participated in a _____.
A. floating exchange rate system

B. currency board system
C. fixed exchange rate system
D. pegged exchange rate system
In a fixed exchange rate system, the values of a set of currencies are fixed against each other at
some mutually agreed upon exchange rate. Prior to the introduction of the euro, many EU
countries participated in a fixed exchange rate system.

Blooms: Apply
11-74
Education.
Gradable: automatic
90. _____ are popular among many of the world's smaller nations.
A. Floating exchange rates

B. Full fixed exchange rates
C. Fixed exchange rates
D. Pegged exchange rates
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 is that it imposes
monetary discipline on a country and leads to low inflation.

Blooms: Apply
Gradable: automatic
regimes.
11-75
Education.
91. The International Monetary Fund has been criticized for exacerbating moral hazard:
A. with its rescue programs.

B. by increasing the probability of debt default.
C. making loans to countries that are trying to reduce national debt by "playing the market."
D. by refusing to bail out banks that made loans to overleveraged Asian companies during the
1990s.
go wrong. The IMF has been criticized for exacerbating moral hazard with its rescue programs.
According to critics, many Japanese and Western banks made loans to overleveraged Asian
companies during the 1990s, and should now be forced to pay the price for their actions. Instead,
the IMF, through its rescue package, is reducing the probability of debt default and effectively
bailing out the banks.

Blooms: Apply
Gradable: automatic
11-76
Education.
92. A _____ 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. currency crisis
B. banking crisis
D. domestic debt crisis
exchange rate. In contrast, 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. Finally, a foreign
debt crisis is a situation in which a country cannot service its foreign debt obligations, whether
private sector or government debt.
These crises tend to have common underlying macroeconomic causes: high relative price inflation
rates, a widening current account deficit, excessive expansion of domestic borrowing, and asset
price inflation (such as sharp increases in stock and property prices).

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Essay Questions
11-77
Education.
93. What is international monetary system? What are the major trading currencies?
rates. The four major trading currencies are the U.S. dollar, the European Union's euro, the
Japanese yen, and the British pound.

Blooms: Remember
Difficulty: 3 Hard
Gradable: manual
94. Compare and contrast a pegged exchange system with a dirty-float system of exchange rates.
determined by the reference currency exchange rate. Some countries, while not adopting a formal
pegged rate, try to hold the value of their currency within some range against an important
reference currency such as the U.S. dollar, or a "basket" of currencies. This is referred to as a dirty
float.

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual
11-78
Education.
95. What is gold standard? What was the major advantage of the system?
States, had adopted the gold standard. Because each currency was linked to gold under the
system, it was easy to determine the value of any currency in units of any other currency.
The great strength claimed for the gold standard was that it contained a powerful mechanism for
achieving balance-of-trade equilibrium by all countries.

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual
96. With the help of an example, explain how balance-of-trade equilibrium is maintained under the
gold standard.
A country is in balance-of-trade equilibrium when the income its residents earn from exports is
equal to the money its residents pay to other countries for imports (the current account of its
balance of payments is in balance). Under the gold standard, when Japan has a trade surplus, there
will be a net flow of gold from the U.S. to Japan. These gold flows automatically reduce the U.S.
money supply and swell Japan's money supply. An increase in money supply will raise prices in
Japan, while a decrease in the U.S. money supply will push U.S. prices downward. The rise in the
price of Japanese goods will decrease demand for these goods, while the fall in the prices of U.S.
goods will increase demand for these goods. Thus, Japan will start to buy more from the U.S., and
the U.S. will buy less from Japan, until a balance-of-trade equilibrium is achieved.

Blooms: Apply
Difficulty: 3 Hard
Gradable: manual
11-79
Education.
97. What is the Bretton Woods agreement? How was it different from the gold standard?
The Bretton Woods agreement, signed in 1944, called for a system of fixed exchange rates whereby
countries would fix the value of their currency to gold. Unlike the gold standard, countries were not
required to exchange their currencies for gold. Instead, only the dollar remained convertible to
gold, and each country decided what its exchange rate relative to the dollar was to be and then
calculated the gold par value of the currency based on that selected dollar exchange rate. All
participating countries agreed to try to maintain the value of their currencies within 1 percent of the
par value by intervening in the market as necessary.

Blooms: Understand
Difficulty: 3 Hard
Gradable: manual
98. Identify the multinational institutions that were established at the Bretton Woods agreement. What
were their roles in the international monetary system?
At the Bretton Woods meeting in 1944, two multinational institutions, the International Monetary
Fund (IMF) and the World Bank, were established. The IMF was established to maintain order in the
international monetary system. The IMF sought to achieve this goal through a combination of
discipline and flexibility. The World Bank, also known as the International Bank for Reconstruction
and Development, was established to help the war-torn economies of Europe rebuild. However, the
World Bank soon turned its attention to providing assistance to other countries, particularly Third
World countries.

Blooms: Understand
Difficulty: 3 Hard
Gradable: manual
11-80
Education.
99. Explain the events that led to the failure of the Bretton Woods system.
The Bretton Woods system started to fall apart in the late 1960s, and finally collapsed in 1973. The
system fell apart because the U.S. dollar, which played a central role in the regime, was being
pressured to devalue. To finance both the Vietnam conflict and his welfare programs, President
Lyndon Johnson backed an increase in U.S. government spending that was not financed by an
increase in taxes. Instead, it was financed by an increase in the money supply, which led to a rise in
price inflation from less than 4 percent in 1966 to close to 9 percent by 1968.
The increase in inflation and the worsening of the U.S. foreign trade position gave rise to
speculation in the foreign exchange market that the dollar would be devalued. Things came to a
head in the spring of 1971 when U.S. trade figures showed that for the first time since 1945, the
United States was importing more than it was exporting.
Then President, Nixon finally announced in 1971 that the dollar was no longer convertible to gold,
and that a 10 percent tariff would remain in effect until all trading partners agreed to revalue their
currencies relative to the dollar. Even after this move and a subsequent revaluation of currencies
relative to the dollar, speculation continued that dollar would be further devalued until at last,
currencies were allowed to float freely, and the fixed exchange rate system ended.

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual
11-81
Education.
100. Discuss the significance of the Jamaica Agreement.
The 1976 Jamaica Agreement formalized the floating exchange rate regime that followed the
collapse of Bretton Woods. The agreement established the rules for the international monetary
system that are in place today. Under the agreement, floating rates were declared to be acceptable,
gold was abandoned as a reserve asset, and total annual IMF quotas were increased. Under the
Jamaica Agreement, the IMF continued in its role of helping countries cope with macroeconomic
and exchange rate problems.

Blooms: Apply
Difficulty: 3 Hard
Gradable: manual
101. Discuss the arguments that favor a floating exchange rate system against a fixed exchange rate
system.
There are two main elements in the case for floating exchange rates: monetary policy autonomy
and automatic trade balance adjustments. Under a fixed exchange rate system, a country's ability to
expand or contract its money supply is limited by the need to maintain exchange rate parity. Under
a floating exchange rate system, however, monetary control is restored to the government enabling
a government to pursue domestic policies that involve expanding or contracting the money supply
without worrying about maintaining exchange rate parity. Similarly, a floating exchange rate system
a country can correct a trade imbalance through currency adjustments, a practice that is impossible
under a fixed rate system.

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual
11-82
Education.
102. Present the common arguments that favor fixed exchange rates.
The case for fixed exchange rates revolves around arguments about monetary discipline,
speculation, uncertainty, and the lack of connection between the trade balance and exchange rates.
Supporters of a fixed exchange rate system suggest that the monetary discipline required by a fixed
exchange rate system allows a government to ignore political pressures that might result in a rapid
expansion of the money supply and high inflation.
Advocates of fixed exchange rates argue that the system limits the destabilizing effects of
speculation. Similarly, because the fixed rate system is more predictable, according to supporters,
international trade and investment will be encouraged. Finally, advocates of fixed exchange rates
suggest that trade deficits are determined by the balance between savings and investment in a
country, not by the external value of its currency. Therefore, the need for floating exchange rates to
correct trade imbalances is not valid.

Blooms: Apply
Difficulty: 3 Hard
Gradable: manual
11-83
Education.
103. Describe the different exchange rate policies that are in practice today.
Governments around the world pursue a number of different exchange rate policies. These range
from a pure "free float" where the exchange rate is determined by market forces to a pegged
system that has some aspects of the pre-1973 Bretton Woods system of fixed exchange rates. Some
14 percent of the IMF's members allow their currency to float freely. Another 26 percent intervene
in only a limited way (the so-called managed float). A further 22 percent of IMF members now have
no separate legal tender of their own.
The remaining countries use more inflexible systems, including a fixed peg arrangement (28
percent) under which they peg their currencies to other currencies, such as the U.S. dollar or the
euro, or to a basket of currencies. Other countries have adopted a system under which their
exchange rate is allowed to fluctuate against other currencies within a target zone (an adjustable
peg system).

Blooms: Apply
Difficulty: 3 Hard
Gradable: manual
regimes.
11-84
Education.
104. What is a currency board? Why do countries choose this type of system? What are the
disadvantages of this type of arrangement?
demand into another currency at a fixed exchange rate. To make the commitment credible, the
percent of the domestic currency issued. The system is attractive because it limits the ability of the
government to print money, and thereby create inflationary pressure. Under a strict currency board,
interest rates will adjust automatically. However, critics point out that if local inflation rates remain
higher than the inflation rate in the country to which the currency is pegged, the currencies of
countries with currency boards can become uncompetitive and overvalued. Also, the system does
not permit governments to set interest rates.

Blooms: Apply
Difficulty: 3 Hard
Gradable: manual
regimes.
105. Recent policies of the International Monetary Fund have drawn a lot of criticism. Discuss these
criticisms.
The IMF‘s policies designed to cool overheated economies by reining in inflation and reducing
government spending have been highly criticized. One criticism is that the IMF's "one-size-fits-all"
approach to macroeconomic policy is inappropriate for many countries. The IMF has also been
accused of intensifying moral hazard through its rescue packages. Finally, it has been suggested
that the IMF has become too powerful for an institution that lacks any real mechanism for
accountability.

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual
11-85
Education.
106. How can international companies reduce their economic exposure in a world of constantly
fluctuating exchange rates?
For companies operating in a world of volatile exchange rates, it is important to pursue strategies
that reduce the economic exposure of the firm. One way to maintain strategic flexibility is to
disperse production to different locations around the globe. This strategy allows companies to
hedge currency fluctuations. Companies can also build strategic flexibility by contracting out their
manufacturing. This strategy allows a company to shift suppliers from country to country in
response to changes in relative costs brought about by exchange rate movements. Finally,
companies should be aware of IMF macroeconomic policies that might affect their operations. IMF
policies often result in a sharp contraction in demand in the short run, and an expansion of demand
in the long run. Companies need to follow the IMF policies and adjust their strategies accordingly.

Blooms: Apply
Difficulty: 3 Hard
Gradable: manual
107. Do you think businesses can influence government policies? Explain your answer.
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. Student answers will vary for this question.

Blooms: Analyze
Difficulty: 3 Hard
11-86
Education.
Gradable: manual
11-87
Education.

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Chapter 11

The International Monetary System

True / False Questions

Multiple Choice Questions

A. pegged exchange rate

27. Under a pegged exchange rate regime, a country:

28. International Development Association loans:

A. receive direct funding from the World Bank.

A. not permitted to sell their own gold reserves

A. despite running a growing trade deficit.

A. gave U.S goods a competitive advantage over others.

A. fixed exchange rate regime

33. The monetary autonomy argument is supported by the advocates of _____.

A. argue that floating rates help adjust trade imbalances.

A. fixed exchange rate

39. A currency crisis occurs when:

A. investors lose confidence in a country's banking system.

A. are conditional loans.

A. high inflation rates

A. will occur in the next few weeks.

A. currency board exchange

A. fixed against other currencies based on an agreement.

48. A dirty float refers to a situation in which:

A. fixed exchange rate

51. Gold par value refers to the:

A. ratio of the price of gold in a currency to price of gold in U.S. dollars.

52. A country is said to be in balance-of-trade equilibrium when:

53. A country's trade balance is in surplus when:

A. its exports are more than its imports.

55. The agreement reached at Bretton Woods established the _____.

A. International Monetary Fund

A. establish an international monetary system.

A. Imports will become less attractive in that country.

A. It is likely to create high unemployment in some cases.

61. Which of the following is a function of World Bank?

A. Implementing a rigid fixed exchange rate regime

A. Worsening of Great Britain's balance of trade

A. The exchange rates of a currency are determined by market forces.

67. Which of the following arguments is in favor of floating exchange rates?

68. The monetary autonomy argument holds that:

A. each country should be allowed to choose its own inflation rate.

A. Monetary discipline is the most important determinant of a strong economy.

A. External agencies should not interfere in the monetary policies of a country.

71. Those in favor of floating exchange rate claim that ____.

A. uncertainty in monetary markets dampens the growth of international trade

75. Which of the following statements is true of pegged exchange rates?

A. A pegged exchange rate allows a country's currency to be determined by market forces.

A. another currency at a fixed exchange rate.

77. Under a currency board system:

A. inflation rates are maintained at high level.

A. the loss of confidence in a country's banking system.

79. Moral hazard arises when people behave recklessly because:

A. of the restrictions that exist in a country's monetary policy.

A. IMF lacks any real mechanism for accountability.

81. Which of the following is a characteristic of a foreign debt crisis?

A. Narrowing current account deficit

A. Finding a large supplier to supply all the raw materials

A. having multiple suppliers attracts subsidies from government.

A. Economic and Social Council (ECOSOC)

A. benefit from a sharp expansion of demand in the long term

87. In the face of unpredictable movements in exchange rates, businesses should:

A. pursue strategies that will reduce their economic exposure.

A. pegged exchange rate regime