THE UNIVERSITY OF SYDNEY

Macroeconomic Theory: ECON5002

Week Ten

PRACTICE QUESTIONS

1) In a flexible exchange rate regime, an increase in the foreign interest rate (i*) will
cause:
A) a movement along the IP curve.
B) neither a shift nor movement along the IP curve.
C) the IP curve to shift to the right/down.
D) the IP curve to shift to the left/up.

2) For this question, assume that the economy is operating in a fixed exchange rate
regime and that perfect capital mobility exists. Given this information, which of the
following will occur?
A) The central bank cannot use monetary policy to affect domestic output.
B) An expansionary fiscal policy will require that the central bank increase the
money supply.
C) The domestic and foreign interest rates must be equal.
D) all of the above
E) none of the above

3) Assume the interest parity condition holds and that initially i = i*. A reduction in
the foreign interest rate (i*) will cause:
A) an expected depreciation of the domestic currency.
B) an increase in E.
C) an increase in the demand for the domestic currency.
D) all of the above

4) Assume that the interest parity condition holds. Also assume that the U.S. interest
rate is 6% while the U.K. interest rate is 8%. Given this information, financial
markets expect the pound to:
A) appreciate by 6%.
B) appreciate by 2%.
C) depreciate by 14%.
D) depreciate by 2%.
E) appreciate by 4%.

5) An individual will be indifferent between holding foreign or domestic bonds

when which of the following conditions holds?
A) the Marshall-Lerner condition holds
B) the expected rate of depreciation of the domestic currency is zero
C) the foreign and domestic interest rates are equal
D) none of the above

6) In an open economy under flexible exchange rates, a reduction in the money

supply will always cause:
A) an increase in the exchange rate, E.
B) an increase in the interest rate.
C) a reduction in output.
D) all of the above
E) only A and B

7) Assume policy makers in a fixed exchange rate regime decide to peg the
exchange rate at a lower level. This is called:
A) a revaluation.
B) a depreciation.
C) a devaluation.
D) an appreciation.

8) An increase in the money supply in a flexible exchange rate regime will cause:
A) a depreciation of the domestic currency.
B) no change in E.
C) an increase in E.
D) a shift of the IP curve.

9) Suppose policy makers are pursuing a policy to fix the exchange rate. In such a
system with perfect capital mobility, an open market sale of domestic bonds by the
domestic central bank will eventually result in:
A) a permanent reduction in the monetary base.
B) a gradual reduction in the domestic interest rate.
C) a permanent increase in the monetary base.
D) a change in the composition of the monetary base.

10) Under a fixed exchange rate regime, the central bank must act to keep:
A) E = 1.
B) P = P*.
C) the real exchange rate fixed.
D) i = i*.
E) none of the above