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Chapter 12
MGT 302 Exam 2
| Question | Answer |
|---|---|
| International Monetary systen | Sets of internationally agreed rules, conventions and supporting institutions that facilitate trade, cross border investment and generally, the reallocation of capital between nation states. |
| floating exchange rate | a system under which the exchange rate for converting one currency into another is continuously adjusted depending on the laws of supply and demand. |
| pegged exchange rate (developing nations) | currency value is fixed relative to a reference currency |
| Other 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 US dollar or a "basket" of currencies. This is referred to as a | managed float system (aka. dirty float system) |
| the values of the U.S dollar, the EU euro, the Japanese yen, and the British pound are determined by market forces, government intervention and fluctuate day to day. This is an example of | Floating exchange rate because country allows the foreign exchange market to determine the relative value of a currency |
| if the US dollar goes up, so does the Vietnamese dong. This is an example of | pegged exchange rate |
| in managed float system, "managed' is because | the central bank of a country will intervene in the foreign exchange market to try to maintain the value of its currency if it depreciates or appreciates too rapidly against an important reference currency |
| in managed float system, "float" is because | the value of the currency is determined by market forces |
| The value of the Pakistani currency, the rupee, has been linked to a basket of other currencies—including the dollar, yen, and euro—and it is allowed to vary in value against individual currencies, but only within limits. This is an example of a | managed float system |
| Fixed exchange rate | countries fix their currencies against each other at some mutually agreed on exchange rate. The currency of one country is linked to the currency of another country or a commonly traded |
| Dollarization is when | a country abandons its own currency and instead adopts another currency, typically the U.S dollar. |
| Dollarization is used when | when a country is suffering from severe macroeconomic problems, such as high inflation, that are making its own currency worthless |
| Gold standard is | the practice of pegging currencies to gold and guarantee their convertibility |
| Gold par value refers to | the amount of currency needed to purchase one ounce of gold |
| the great strength of the gold standard was that it contained a powerful mechanism for achieving | balance-of-trade equilibrium by all countries |
| 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 amount of its balance of payments is in balance.) |
| how is balance of trade maintained under the gold standard | Countries with a balance of trade surplus, meaning they export more than they import receive gold inflows. While countries with a balance of trade deficit, meaning they import more than they export, experience an outflow of gold. |
| Based on the agreements on Bretton Woods, the International Monetary Fund (IMF) task was to | maintain order in the international monetary system through a combination of discipline and flexibility. This meant policing fixed exchange rates, stopping competitive devaluations, and bring stability. |
| The agreement reached at Bretton Woods established two multinational institutions which are they | the International Monetary Fund (IMF) and the World Bank |
| the task of the World Bank was to | promote general economic development |
| Under the Bretton Woods agreement, the system of fixed exchange rates meant that | all countries were to fix/pegging 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. |
| Another aspect of the Bretton Woods agreement was a commitment not to use devaluation as. weapon of competitive trade policy. However there was an exception, which was it? | if a currency became too weak to defend, devaluation of up to 10% would be allowed without any formal approval by the IMF. A larger devaluation though, would require an approval. |
| a fixed exchange rate imposes discipline by | putting a brake on competitive devaluations and brings stability to the world trade environment |
| what a a second way a fixed exchange rate imposes discipline | by imposing monetary discipline on countries, thereby curtailing price inflation |
| the IMF imposed flexibility into the system through what two major features? | the IMF lending facilities and adjustable parities |
| what do the IMF lending facilities do | lend foreign currencies to members to tide them over during short periods of balance-of-payments deficits. These IMF funds would buy time for countries to bring down their inflation rates and reduce their balance-of-payments deficit. |
| what do the IMF adjustable parities do | they allowed for devaluation of a country's currency by more than 10% if the IFM agreed that a country's balance of payments was in "fundamental disequilibrium" |
| the world bank lends money under which two schemes | the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA) |
| under the International Bank for Reconstruction and Development scheme | the bank offers low-interest loans to risky customers whose credit rating is often poor, such as governments of underdeveloped nations |
| under the International Development Association scheme | loans would go only to the poorest countries. They receive grants and interest- free loans. |
| what was the major problem with the gold standard | that no multinational institution could stop countries from engaging in competitive devaluations. |
| what was the driving force for the appreciation in the value of the dollar despite the U.S still having a balance of payments deficit? | Foreigners given their continuing investment in U.S financial assets, primarily stocks and bonds. The inward investment was due to the belief that U.S financial assets offered a favorable rate of return. |
| the case in support of floating exchange rates rests on which three main elements | monetary policy autonomy, automatic trade balance adjustments, and economic recovery following a severe economic crisis |
| Advocates of floating exchange rates argue that they provide monetary policy autonomy which means | that it gives a country the ability to expand or contract its money supply as it sees fit |
| Advocates of floating exchange rates argue that they allow for automatic trade balance adjustments which means | if a country is having a trade deficit, the imbalance between supply and demand of that country's currency (supply exceeds demand) will lead to depreciation in its exchange rate making exports cheaper, this depreciation should correct the trade deficit. |
| Advocates of floating exchange rates argue that it helps with economic recoveries which means that | exchange rate adjustments can help a country deal with economic crises. When crises happen, the currency can decline on foreign exchange markets and become so cheap that it starts to stimulate exports, thereby, stimulating economic recovery. |
| The case for fixed exchange rates rest on which arguments | monetary discipline, speculation, uncertainty, and the lack of connection between the trade balance and exchange rates. |
| the argument of fixed rates bringing monetary discipline means | that fixed exchange rate ensures that governments do not expand their money supplies at inflationary rates. While advocates of floating exchange rates think the opposite, that a country should choose its own inflation rate (the monetary autonomy argument) |
| the argument of fixed rates creating speculation means that | this can cause fluctuations in exchange rates. For instance, the dollar's rapid rise and fall during the 1980's had nothing to do with comparative advantage inflation rates or trade deficit. |
| the argument of fixed rates creating uncertainty means that | it dampens the growth of international trade and investment. Speculation adds to the uncertainty of future exchange rate movements and this makes business planning difficult and adds risk to importing, exporting, and investing. |
| the argument of those in favor of fixed rates that there is not a link between the exchange rate, the trade balance, and economic growth means that | they claim that a depreciating exchange rate will not boost exports and reduce imports, as advocates of floating exchange rates claim; it will only boost price inflation which wipes out any gains in cost competitiveness gained from currency depreciation |
| As with a full fixed exchange rate regime, a pegged exchange rate imposes what? | monetary discipline in a country and leads to low inflation. This is because the country whose currency is chosen for the peg must also pursue a sound monetary policy. |
| A country introduces a currency board as a way of | controlling a country's currency. It commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate. |
| A drawback of currency boards is that | the currencies of countries with currency boards can become noncompetitive and overvalued and this is because sometimes local inflation rates remain higher than the inflation rate in the country to which the currency is pegged. |
| Another drawback of currency boards is that | government lacks the ability to set interest rates. This is because they are instead set by the government whose currency is pegged to. For example, interest rates in Honk Kong are set by the U.S Federal Reserve. |
| 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 rates. |
| A currency crisis occurs when a ______ attack on the ______ of a currency results in ____ | speculative; exchange value ; 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 rates |
| 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 |
| A foreign debt crisis is | when a country cannot service its foreign debt obligations, whether private sector or government debt. |
| one criticism is that the IMF's traditional policy prescriptions represent a | "one size fits all" approach to macroeconomic policy that is inappropriate for many countries. The IMF applies the same policies to all countries and this may not be adequate since not all countries are well suited for all of them. |
| A second criticism of the IMF is that | its rescue efforts are intensifying a problem known as moral hazard. By providing loans to such countries, the IMF is reducing the probability of debt default and instead bailing out the banks whose loans gave rise to this situation. |
| A moral hazard arises when | when people behave recklessly because they know they will be saved if things go wrong. Ex: the IMF saving many countries by providing them with loans |
| the final criticism of the IMF is that | it has become too powerful for an institution that lacks any real mechanism for accountability. The IMF has determined a lot of macroeconomic policies, yet it has a staff of less than 1,000 who lack the expertise required to do a good gob. |
| one of the ways international companies can reduce their economic exposure is by | dispersing production around the globe. This allows to hedge against currency fluctuations |
| a second way international companies can reduce their economic exposure is by | building strategic flexibility which involved shifting suppliers in response to changes in relative costs brought about by exchange rate movements |
| a third way international companies can reduce their economic exposure is by | being aware of the IMF policies and follow them accordingly |
| Following the Industrial Revolution, to allow for the use of paper currencies to finance trade, governments agreed to convert the paper currency into ______on demand at a fixed rate. | gold |
| The United States raised the dollar price of gold by nearly $15 per ounce in 1934. Which of the following was true in the given scenario? | the dollar was worth less because more dollars were needed to buy an ounce of gold than before |
| A currency board would look to _____exchange rates when converting currency. | fixed |
| A fixed exchange rate system is supported by monetary ______ while the floating exchange rate system supports the monetary ____ argument. | discipline ; autonomy |
| Based on the present system, speculative buying and selling of currency tends to create ____ movements in exchange rates. | volatile |
Created by:
yesly810