REVIEW TOPICS FOR EXAM #2

FIXED EXCHANGE RATE REGIMES

• How could a central bank "sterilize" the purchase of foreign assets?
• How could a central bank "sterilize" the sale of foreign assets?
• What is the point of "sterilizing" an operation?
• If the officials who are in charge of pegging a currency at a fixed rate observe upward pressure on the exchange rate, how should they intervene?
• If the officials who are in charge of pegging a currency at a fixed rate observe downward pressure on the exchange rate, how should they intervene?
• Under a rigidly fixed exchange rate system, if the spot rate is $1.50/unit of the foreign currency, what should be the value of the future expected exchange rate be? Why?
• Under a rigidly fixed exchange rate regime, what is the interest parity condition?
• If foreign interest rates increase, what must a country that is pegging its currency to the foreign one do in order to maintain the peg? Explain.
• Why is monetary policy considered to be on "autopilot" under a fixed exchange rate regime? Explain carefully.
• What would happen if a nation tried to stimulate the economy by implementing an "easy money" policy if it operated under a fixed exchange rate system? Use the AA-DD model to explain.
• Use the AA-DD model to show the effects of expansionary fiscal policy in a nation that operated under a fixed exchange rate system.
• Can a country that is operating under a fixed exchange rate system ever change the peg? Explain.
• What does it mean to say that a country has devalued its currency? Revalued?
• Why would a country ever devalue? (give three reasons)
• How could a nation bring about a devaluation? (Use AA-DD to demonstrate)
• What is a balance of payments (BOP) crisis?
• Explain (very carefully) how an expected devaluation can cause a BOP crisis.
• Under a reserve currency system, the reserve country (i.e. the one that issues the reserve currency) is in a preferred position. Why? (hint: discuss asymmetry)
• Under a gold standard system, the price-specie-flow mechanism is supposed to cause the international monetary system to adjust. Explain this process.

 POLICY OPTIONS UNDER A BRETTON WOODS SYSTEM

• What was the Bretton Woods System?
• Countries were supposed to desire internal and external balance. What do these terms mean?
• What variables can policymakers target in their pursuit of short-run internal balance?
• Why isn’t monetary policy an option?
• What variables can policymakers target in their pursuit of short-run external balance?
• Why isn’t monetary policy an option?
• Draw the XX-YY model, labeling both curves and axes correctly.
• What is true at every point along XX?
• What is true at every point along YY?
• Do you understand what is "going on" at every conceivable point in the graph (i.e. those "on" and "off" the XX and YY schedules?
• Why does being at a point other than equilibrium imply a policy dilemma?

THE MACRO POLICY IN THE EUROZONE

• What is the "Eurozone"?
• How many countries are members of the Eurozone? Which was the last to join?
• What kind of monetary system now exists in the Eurozone?
• What does EMU stand for?
• What is the Maastricht Treaty?
• What are the major "costs" associated with adopting the euro (i.e. giving up a sovereign currency)? List and explain at least two.
• What kinds of benefits did countries believe would offset these costs?  List and explain at least three.
• What does the GG schedulel show?
• What does the LL schedule show?
• Together, the GG and LL schedules are used to show something specific. What is it?
• What is the Optimum Currency Area (OCA) theory?
• Do Krugman and Obstfeld believe that the Eurozone is an OCA? Explain (specifically!) what they argue.
• How is monetary policy conducted within the Eurozone? (i.e. What is the relevant institution? What is the primary objective of the ESCB? What role do national central banks (NCBs) play? How has the relationship between NCBs and national governments changed?)
• Discuss the three fiscal constraints discussed in lecture.
• Which constraint do most economists tend to emphasize?
• Which constraint did your instructor emphasize? Why?
• Can governments that have adopted the euro use fiscal policy to achieve internal balance? Why/why not?
• Explain the Stability and Growth Pact?
• Define "internal balance".
• Define "external balance".  

 INTERNATIONAL MONETARY SYSTEMS

• We usually think of current account surpluses as desirable, since they add to the demand for a nation's output. But Krugman and Obstfeld caution that excessive current account balances can cause problems. Explain their arguments.
• Were countries that operated under a Gold Standard free to implement monetary policy in any way they saw fit to maintain full employment? Explain.
• Is a Gold Standard more like a fixed or floating exchange rate system?
• Suppose that the world consists of two countries (A and B), each operating under a Gold Standard. Now suppose that country A suddenly begins to run a current account deficit. Using the price-specie-flow argument, explain how gold flows should return both countries to a balance of payments equilibrium.
• Explain the Bretton Woods agreement. How many nations participated? What, exactly, did these nations agree to do? Which country bore responsibility for ensuring convertibility to gold?
• Why did the Bretton Woods system eventually break down?
• Draw the XX-II model.
• What is true at every point along the XX curve?
• What is true at every point along II?
• What is true at the point of intersection between XX and II?
• Plot a point (anywhere) away from XX and II. Was it possible, under Bretton Woods, for a country to use fiscal policy to move onto the XX curve?  How?  Was it possible for a country to use fiscal policy to move onto the II curve? How? Was it possible for a country to move to the point of intersection between XX and II?  Explain.

FLOATING EXCHANGE RATES

• Proponents of floating (or flexible) exchange rate systems usually cite three main advantages to this form of arrangement. List and explain each of them.
• Opponents of floating exchange rates usually list five arguments against floating exchange rates. List and explain each of them.
• Does the actual experience with flexible exchange rates support the critics or the opponents of flexible exchange rates? Explain.

THE GLOBAL CAPITAL MARKET

• Explain the concept of offshore banking.
• What three primary reasons does Krugman give for the rapid growth of offshore banking activity since the 1960s? Explain.
• What is the difference between a Eurocurrency deposit and a Eurodollar deposit?
• What is Eurocurrency trading?
• What is a Eurobank?
• Identify at least four reasons for the early growth in the Eurodollar market.
• Why do some economists believe that the proliferation of Eurocurrency deposits might undermine macro stability? [give two reasons] Explain carefully.
• What does it mean to say that market participants are risk averse?
• How is portfolio diversification used to minimize risk?
• List and describe five safeguards that have been put in place to prevent bank failures in the United States.
• Whose job is it to regulate international banking activities? Develop your answer into a short essay.