Question

QUESTION 9. In recent years, it has been suggested that both China and the US have engaged in currency manipulation or ‘competitive devaluations’. All else the same, from this we can conclude:

A.  Chinese goods will be less expensive in US markets in the short-run, but US goods will be more expensive in China.

B.  US goods will be less expensive in China in the short-run, but Chinese goods will be more expensive in the US.

C. Chinese and US made goods will be cheaper in both China and the US.

D.  Chinese and US made goods will be cheaper in markets outside the US and China that do not tie their currencies to the US dollar or the Renminbi.

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QUESTION 10. Suppose the world is operating under a fixed exchange rate system like Bretton Woods, and Germany (not a reserve currency country) is experiencing an economic boom and has an excessive trade account surplus.  If the government does nothing*  

A. The country will ultimately drift deeper into a boom and the trade account will grow even more; only a revaluation of the currency will bring it back to internal balance (full employment) and external balance (trade account balance). Speculators have no incentive to run to the German mark, since revaluation is a forgone conclusion - everyone knows it, so there are no profits to be made by betting on the mark.

B. Interest rates will start to rise in Germany, due to the boom. Since the country is committed to a fixed exchange rate, Germany will need to increase the money supply in order to maintain the fixed exchange rate. This will eventually raises prices in Germany, thereby worsening Germany’s trade account. All else the same, the economy will return to full employment as the German trade account worsens.

C. The situation will correct itself without a revaluation, though it will take time, due to the J-Curve effect.

D. There is no way a country can simultaneously experience a boom and an excessive trade account surplus under a fixed exchange rate system - a high level of output means the country will import more goods; the country will experience a trade deficit, not a trade surplus.

E. None of the above.

* REMARK: By ‘does nothing’ we assume the country does not renege on its commitment to fix the exchange rate.

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QUESTION 11. Replace Germany with China in the question above, in the 2000s. What might be different?

A.  Unlike Germany in the early 1970s, China has had much technological change which has increased productivity. This will temper the ensuing effects of the boom and expansion in exports on prices in China, thereby making the adjustment in the current accounts much more difficult for her trading partners.

B.  Germany’s monetary policy was determined in Washington; China’s is determined in Bejing.

C.  The emergence of the Euro means that the Chinese can choose among the Euro or the Dollar to hold as foreign reserves. This in turn makes the effects of the economic boom and the excess surpluses fundamentally different than described above.

D.  It is unlikely a J-Curve effect will emerge, based on the type of goods China exports.

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QUESTION 12. One purpose of a devaluation of the Home currency (E rises) following currency crises is _____________. It is risky because ________.

A.  The devaluation will compensate speculators for their losses. The devaluation can undershoot its long-run value.

B.  The devaluation will raise the return on Home currency assets. The devaluation can undershoot its long-run value.

C. The devaluation will raise the cost of Foreign-made goods and increase the trade account. The J-curve effect may be present and the trade account can worsen, instead of improve, making the situation worse.

D. The devaluation will increase the value of the Foreign assets held by the central bank. The devaluation will make Foreign goods more expensive in the Home market.

Answer 1

9) while both the nation will practice competitive devaluation, both of the nation will try to capture each others price making their export cheaper and import dearer, so in this case both chines and US made goods will be cheaper in both chine and US.

so the correct option is c

10) as there is fixed exchange rate system prevailed in the Germany, the country will follow option B to correct the situation.

11)