Chapter 20, Problem 1QAP

a)

To determine

To check:Whetherthe sentence is true, false or uncertain, “If nominal exchange rate is fixed, the real exchange rate is fixed”

Explanation of Solution

The nominal effective exchange rate (NEER) is a weighted unadjusted average rate at which one country exchanges currency for a basket of multiple foreign currencies. The nominal exchange rate reflects the amount of domestic currency required to buy foreign currency.

It is true because the nominal exchange rate is the foreign currency price of a domestic currency. In this case the real and nominal exchange rates will be heading in the same direction.

Economics Concept Introduction

Introduction: Whereas the nominal exchange rate is reflective of how much foreign currency can be exchanged for a unit of domestic currency, the actual exchange rate is reflective of how much goods and services can be exchanged for goods and services in a foreign country.

b)

To determine

To check:Whetherthe sentence is true, false or uncertain, “When domestic inflation equals foreign inflation, the real exchange rate is fixed”

Explanation of Solution

Inflation is a quantitative measure of the rate at which a basket of selected goods and services raises the average price level in an economy for a given period of time. This is the increase in the general price point, where a currency unit simply buys less than it did in previous times. Hence inflation, often measured as a percentage, signals a fall in the buying power of a nation's currency.

It is true as the domestic inflation equals to the foreign inflation, the real exchange rate remain constant.

Economics Concept Introduction

Introduction: In economics, inflation reflects a gradual rise in the average price level of goods and services in the economy over time. Economists usually assume that unsustainable growth in the money supply is triggered by extremely high levels of inflation and hyperinflation.

c)

To determine

To check:Whetherthe sentence is true, false or uncertain, “devaluation is an increase in the nominal exchange rate”

Explanation of Solution

Devaluation is the deliberate downward adjustment of a country's money's value relative to another currency, currency category, or currency standard. Countries with a fixed exchange rate or a semi-fixed exchange rate use this instrument of monetary policy. It is often confused with depreciation, which is the opposite of revaluation, which refers to re-adjusting the exchange rate of a currency.

It is false since the exchange-rate devaluation reduces the domestic currency value.

Economics Concept Introduction

Introduction:Devaluation is an official reduction of the currency of the country's value within a fixed exchange rate.

d)

To determine

To check:Whether the sentence is true, false or uncertain, “Britain’s return to the gold standard caused years of high employment”

Explanation of Solution

The unemployment rate is the proportion of the jobless population, measured as a percentage. It is a lagging predictor, which means it typically rises or falls in the wake of changing economic conditions instead of predicting them. The unemployment rate can be expected to increase when the economy is in bad shape and jobs are scarce. If the economy develops at a reasonable pace, and jobs are fairly plentiful, it can be expected to fall.

It is true, Britain’s return to the gold standard caused years of high unemployment.

Economics Concept Introduction

Introduction: During the First World War the UK had previously abolished the gold standard but reinstated it under Winston Churchill in 1925. In the 19th and early 20th centuries gold standards were common in the western world.

e)

To determine

To check:Whetherthe sentence is true, false or uncertain, “A sudden fear that a country is going to devalue leads to an increase in the domestic interest rate”

Explanation of Solution

Devaluation is the deliberate downward adjustment of a country's money's value relative to another currency, currency category, or currency standard. Countries with a fixed exchange rate or a semi-fixed exchange rate use this instrument of monetary policy. It is often confused with depreciation, which is the opposite of revaluation, which refers to re-adjusting the exchange rate of a currency.

It is true, a domestic interest rate can increase if a country is going for devaluation.

Economics Concept Introduction

Introduction:  Devaluation is an official lowering of the value country’s currency within a fixed exchange rate.

f)

To determine

To check:Whetherthe sentence is true, false or uncertain, “A change in the expected future exchange rate changes the current exchange rate”

Explanation of Solution

Inflation is a quantitative measure of the rate at which a basket of selected goods and services raises the average price level in an economy for a given period of time. This is the increase in the general price point, where a currency unit simply buys less than it did in previous times. Hence inflation, often measured as a percentage, signals a fall in the buying power of a nation's currency.

It is false, because a change in the expected future exchange rate changes the future exchange rate.

Economics Concept Introduction

Introduction: In economics, inflation reflects a gradual rise in the average price level of goods and services in the economy over time. Economists usually assume that unsustainable growth in the money supply is triggered by extremely high levels of inflation and hyperinflation.

g)

To determine

To check:Whetherthe sentence is true, false or uncertain, “The effect of a reduction in domestic interest rates on the exchange rate depends on the length of time domestic interest rates are expected to be below foreign interest rates”

Explanation of Solution

Inflation is a quantitative measure of the rate at which a basket of selected goods and services raises the average price level in an economy for a given period of time. This is the increase in the general price point, where a currency unit simply buys less than it did in previous times. Hence inflation, often measured as a percentage, signals a fall in the buying power of a nation's currency.

It is true; the effect of a reduction in domestic interest rate rates on the exchange rate depends on the time period of domestic interest rates on the exchange rate.

Economics Concept Introduction

Introduction: The domestic rates are classified as currency interest rates expressed in real terms in their own countries.

h)

To determine

To check:Whetherthe sentence is true, false or uncertain, “Because economies tend to return to their natural level of output in the medium run, it makes no difference whether a country chooses a fixed or flexible exchange rate”

Explanation of Solution

Exchange rates for the same country can be different too. There is an onshore rate and out shore rate in some situations. For general, there is always a more favorable exchange rate within a country's border than outside its borders. China is one of the great examples of a country with that rate structure.

It is true, as economies tend to return to their natural level of output in the medium run, it makes no difference whether a country chooses a fixed or flexible exchange rate.

Economics Concept Introduction

Introduction: The natural level of output of an economy exists by effectively using all available resources. This is equal to the highest output level which an economy can support. It's "natural," because after a recession or overheated time an economy returns to its normal level of production.

i)

To determine

To check:Whetherthe sentence is true, false or uncertain, “High labor mobility within Europe makes the Euro area a good candidate for a common currency”

Explanation of Solution

Exchange rates for the same country can be different too. There is an onshore rate and out shore rate in some situations. For general, there is always a more favorable exchange rate within a country's border than outside its borders. China is one of the great examples of a country with that rate structure.

It is true, that high labor mobility within Europe makes the Euro area a good candidate for a common currency.

Economics Concept Introduction

Introduction: Within the European Union, labor mobility has the ability to help raising the severity of the economic crisis.

j)

To determine

To check:Whetherthe sentence is true, false or uncertain, “A currency board is the best way to operate a fixed exchange rate”

Explanation of Solution

Exchange rates for the same country can be different too. There is an onshore rate and out shore rate in some situations. For general, there is always a more favorable exchange rate within a country's border than outside its borders. China is one of the great examples of a country with that rate structure.

It is true, as the currency board is an exchange rate regime based on the full convertibility of a local currency into a reserve one, by a fixed exchange rate.

Economics Concept Introduction

Introduction:  A currency board is a monetary authority which requires a foreign currency to maintain a fixed exchange rate.