Exchange Rate Economics Quiz

Changes in a country's money supply temporarily affect its real money supply and output, but eventually, real variables return to their original levels.

Prices are assumed to be inflexible due to costs associated with changing prices, like menu costs.

In the long run, prices are flexible, and output is determined by a country's resources and technology, independent of nominal money supply.

An increase in a country's money supply leads to a short-term depreciation of its currency.

An increase in a country's money supply leads to long-term depreciation due to investor expectations.

The theory that identical goods should have the same price across countries when expressed in the same currency, assuming no barriers to trade.

The application of the Law of One Price to a basket of goods and services across countries.

Due to factors like taxes, transportation, and varying competition, the Law of One Price rarely holds perfectly in reality.

The relative price of domestic goods to foreign goods, adjusted for exchange rates.

The rate at which one currency can be exchanged for another in the foreign exchange market.

A situation where the value of a currency falls relative to other currencies.

An increase in the value of a currency relative to other currencies.

The demand for a country's goods and services, relative to the demand for foreign goods and services.

The amount of goods and services a country can produce, relative to other countries.

A change in the real exchange rate that makes a country's goods and services cheaper relative to foreign goods and services.

A change in the real exchange rate that makes a country's goods and services more expensive relative to foreign goods and services.

An exchange rate where the price of a specific basket of goods is the same in two different countries, regardless of currency.

A change in the exchange rate is equal to the change in relative prices between two countries. An example? If US inflation rises 5% faster than European inflation, the dollar will depreciate by 5% relative to the euro.

A long-run model where prices are flexible and adjust to ensure absolute PPP holds. It emphasizes the role of money supply and its impact on exchange rates.

A country's currency depreciates in the long run if its inflation rate is higher than other countries. This is because the higher inflation makes domestic goods less competitive, causing the currency to weaken.

The Big Mac index measures the exchange rate between two currencies based on the price of a Big Mac in each country. It's a way to assess whether a currency is overvalued or undervalued.

A currency is undervalued if its market exchange rate is higher than the exchange rate derived from the Big Mac index. This implies that the currency is relatively cheap compared to its purchasing power.

A stylized example of how trade can impact exchange rates. Country A has a higher demand for goods from Country B, leading to an appreciation of Country B's currency relative to Country A's currency.

The relationship between the real exchange rate and the difference in real interest rates between two countries, assuming that investors will not switch investments due to arbitrage opportunities.

The sum of private consumption, private investment, government spending, and net foreign expenditure (current account).

The rise in consumption (C) has a larger effect on AD than the fall in the current account (CA) due to a stronger inclination of domestic residents to consume their own goods over foreign goods.

The point where the aggregate supply (AS) and aggregate demand (AD) curves intersect, representing the equilibrium level of output in the economy.

A curve illustrating all combinations of the exchange rate and income that lead to an equilibrium in the domestic goods market.

Changes in the exchange rate affect domestic goods' relative prices, and in turn, the overall demand for domestic goods. When the nominal exchange rate rises, domestic goods become relatively cheaper, increasing aggregate demand.

The real exchange rate is an important factor in determining a country's aggregate demand because it influences the relative prices of domestic and foreign goods.

An increase in the real exchange rate leads to an increase in the domestic demand for goods and services, as domestic consumers find imported goods relatively more expensive.

A situation where the central bank intervenes in the foreign exchange market to maintain a fixed exchange rate by buying or selling domestic currency.

The policy used by governments to influence the economy through changes in government spending or taxes.

The effect where increased government spending crowds out private investment due to higher interest rates caused by an appreciation of the domestic currency.

The increase in the value of a currency due to market forces.

The decrease in the value of a currency due to market forces.

The deliberate lowering of a fixed exchange rate by a central bank.

The deliberate raising of a fixed exchange rate by a central bank.

A sudden and large-scale movement of capital out of a country, often triggered by economic instability or political uncertainty.

The risk premium reflects the additional return foreign investors demand when investing in domestic assets compared to their own country's assets. It accounts for factors like differences in returns between stocks and bonds in both countries and the risk inherent in investing in a specific country.

The exchange rate between domestic and foreign currencies remains fixed in a fixed exchange rate regime. This means that the central bank intervenes to keep the exchange rate stable, even if economic conditions would naturally lead to fluctuations.

The Gold Standard era (1870-1914) was a period where countries fixed their currencies to a specific amount of gold. This provided a built-in mechanism for adjusting exchange rates based on gold flows.

A reserve currency system (1945-1971) anchored currencies to a single powerful currency, like the US dollar. This provided stability but also made the system vulnerable to the actions of the dominant reserve currency nation.

The Tinbergen rule states that a government can only achieve as many policy objectives as distinct independent policy instruments it has available. If a government wants to achieve both low unemployment and a balanced current account, it needs two independent policy tools to adjust both.

Domestic equilibrium occurs when the economy operates at its natural rate of unemployment. This represents a state of full employment and stable output, where the level of output is determined by factors like consumption, investment, and government spending.

External equilibrium occurs when a country's current account (CA) is balanced, indicating no net borrowing or lending with the rest of the world. This means that the country's imports and exports are in balance.

A nation might desire monetary policy independence to adjust interest rates based on its own economic conditions while simultaneously aiming for a stable exchange rate to promote predictable international trade. However, these desires may be hard to achieve together, posing a challenge for policymakers.