International Economics, 7e (Husted/Melvin)
Chapter 21 Open Economy Macroeconomic Policy and Adjustment
Multiple-Choice Questions
1) Which of the following would not cause the IS curve to shift to the left?
A) a decrease in government expenditures
B) a decrease in the money supply
C) an increase in the domestic price level
D) an increase in taxes
Answer: B
2) The LM curve represents combinations of income and interest rate which
A) clear the goods market.
B) achieve the external equilibrium.
C) clear the money market.
D) achieve internal equilibrium.
Answer: C
3) A point to the left of the BP curve would represent
A) a balance of payments deficit.
B) a balance of payments surplus.
C) internal disequilibrium.
D) Both A and C.
Answer: B
4) An increase in the money supply would
A) shift the LM curve to the left.
B) shift the IS curve to the right.
C) shift the IS curve to the left.
D) shift the LM curve to the right.
Answer: D
5) A point to the left of the LM curve would represent a situation in which
A) money demand is greater than money supply.
B) money supply is greater than money demand.
C) money demand is greater than goods demand.
D) money demand is less than goods demand.
Answer: B
6) Which of the following is not a true statement?
A) The higher the income level, the lower interest rates must be for goods market
equilibrium.
B) The higher the income level, the higher interest rates must be for money market
equilibrium.
C) The higher the income level, the lower the interest rate must be for external balance to
be achieved.
D) Equilibrium occurs at the intersection of the IS, LM, and BP curves.
Answer: C
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7) As interest rates rise, other things equal,
A) investment decreases.
B) money demand decreases.
C) capital inflows increase.
D) All of the above.
Answer: D
8) With fixed exchange rates, perfect asset substitutability, and perfect capital mobility
A) the LM curve is horizontal.
B) the LM curve is vertical.
C) the BP curve is horizontal.
D) the BP curve is vertical.
Answer: C
9) With fixed exchange rates, perfect asset substitutability, and perfect capital mobility
A) fiscal policy is ineffective.
B) monetary policy is ineffective.
C) both fiscal and monetary policy are effective.
D) both fiscal and monetary policy are ineffective.
Answer: B
10) With flexible exchange rates, perfect asset substitutability, and perfect capital mobility,
expansionary monetary policy will cause
A) income to rise, interest rates to fall, and the domestic currency to depreciate.
B) income to fall, interest rates to rise, and the domestic currency to appreciate.
C) income to rise, interest rates to remain unchanged, and the domestic currency to
appreciate.
D) income to rise, interest rates to remain unchanged, and the domestic currency to
depreciate.
Answer: D
11) Which of the following is not a necessary condition for a flat BP curve?
A) perfect capital mobility
B) perfect asset substitutability
C) fixed exchange rates
D) floating exchanges rates
E) Both C and D
Answer: E
12) The world of flexible exchange rates and perfect capital mobility is often called the
A) Keynesian model.
B) Mundell-Fleming model.
C) Monetarist model.
D) Melvin model.
Answer: B
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13) Complete crowding out occurs when
A) monetary policy has no effect on income.
B) fiscal policy has no effect on income.
C) monetary policy has no effect on interest rates.
D) fiscal policy has no effect on interest rates.
Answer: B
14) With floating exchange rates
A) monetary policy is effective.
B) fiscal policy is ineffective.
C) monetary and fiscal policy are effective.
D) fiscal and monetary policy are ineffective.
Answer: A
15) Internal balance describes
A) equilibrium in the goods market.
B) a desired level of trade or capital flows.
C) where the IS and BP curve intersect.
D) a domestic rate of growth consistent with a low unemployment rate.
Answer: D
16) Many economists argue that the sharp reduction in U.S. net exports in the mid 1980s was
due to
A) expansionary U.S. monetary policy.
B) contractionary U.S. monetary policy.
C) expansionary U.S. fiscal policy.
D) contractionary U.S. fiscal policy.
Answer: C
17) If foreign countries simultaneously stimulate their economies rather than follow
independent policies
A) world interest rates would rise and the pressure for exchange rate change would fall.
B) world interest rates would rise and the pressure for exchange rate change would rise.
C) world interest rates would fall and the pressure for exchange rate change would fall.
D) world interest rates would fall and the pressure for exchange rate change would rise.
Answer: A
18) If the United States follows expansionary monetary policy relative to Japan and Germany,
which of the following is not likely to occur?
A) U.S. interest rates will rise relative to Japan and Germany
B) a larger U.S. capital account deficit
C) a depreciation of the dollar
D) lower level of U.S. income
Answer: D
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19) External balance refers to
A) an economy which is on its LM curve.
B) an economy which is on its IS curve.
C) an economy which is on its BP curve.
D) All of the above.
Answer: C
20) With fixed exchange rates, a country
A) cannot conduct independent monetary policy.
B) can conduct independent monetary policy.
C) cannot conduct independent fiscal policy.
D) Both A and C.
Answer: A
True or False Questions
1) Internal balance can be graphically represented as the intersection of the IS curve with the
LM curve.
Answer:
True
Explanation: None Given
2) Points to the left of the IS curve represent excess demand for goods.
Answer:
True
Explanation: None Given
3) The LM curve will shift to the right when government expenditures increase.
Answer:
False
Explanation: None Given
4) The BP curve is upward sloping if assets are perfectly substitutable.
Answer:
False
Explanation: None Given
5) Fiscal policy is most effective when exchange rates are fixed.
Answer:
True
Explanation: None Given
6) At higher income levels the interest rate must be lower to achieve money market
equilibrium.
Answer:
False
Explanation: None Given
7) Monetary policy is most effective at home when exchange rates are flexible.
Answer:
True
Explanation: None Given
8) With perfect asset substitutability and capital mobility the domestic interest rate is equal to
the foreign rate.
Answer:
True
Explanation: None Given
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9) The BP curve presents combinations of y and i that yield balance of trade equilibrium.
Answer:
False
Explanation: None Given
10) The goal of international economic policy cooperation is to allow for greater flexibility in
exchange rates.
Answer:
False
Explanation: None Given
Essay Questions
1) What policies would you recommend to the U.S. government to lower the balance of trade
deficit and decrease net capital inflows?
Answer: Lower the fiscal deficit.
2) Illustrate with a graph the effects of monetary policy on the economy when exchange rates
are flexible.
Answer: Assume perfect asset substitutability and capital mobility, so the BP curve is
horizontal. Shifts in LM will be matched by shifts in IS so that income changes but the
interest rate is fixed.
3) Illustrate with a graph the effects of fiscal policy when exchange rates are fixed.
Answer: Draw horizontal BP curve. Fiscal policy shifts IS. Monetary policy must
accommodate by shifting LM to match IS in order to maintain fixed exchange rate.
4) What was the Plaza Agreement about?
Answer: A coordinated intervention aimed at dollar depreciation.
5) Illustrate the effectiveness of monetary policy with fixed exchange rates.
Answer: The required intervention to maintain the fixed exchange rate will undo any effect on
income of an increase or decrease in the money supply. Illustrate by shifting LM
curve and then explaining how intervention will return LM to original position.
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