ISCTE – IUL, Instituto Universitário de Lisboa

International Macroeconomics
Alexandra Ferreira-Lopes
Intermediate Test – 23.03.2023

Group I
Please choose the correct answer for the following 24 questions. Each question is
worth 0.5 values.

1) When a country's currency depreciates

A) foreigners find that its exports are more expensive, and domestic residents find that
imports from abroad are more expensive.
B) foreigners find that its exports are more expensive, and domestic residents find that
imports from abroad are cheaper.
C) foreigners find that its exports are cheaper; however, domestic residents are not affected.
D) foreigners find that its exports are cheaper and domestic residents find that imports from
abroad are more expensive.
Answer: D

2) Which one of the following statements is the MOST accurate?

A) A depreciation of a country's currency makes its goods cheaper for foreigners.
B) A depreciation of a country's currency makes its goods more expensive for foreigners.
C) A depreciation of a country's currency makes its goods cheaper for its own residents.
D) A depreciation of a country's currency makes its goods cheaper.
Answer: A

3) A foreign exchange swap

A) is a spot sale of a currency.
B) is a forward repurchase of the currency.
C) is a spot sale of a currency combined with a forward repurchase of the currency.
D) is a spot sale of a currency combined with a forward sale of the currency.
Answer: C

4) Which of the following is NOT an example of a financial derivative?

A) forwards
B) bonds
C) swaps
D) futures
Answer: B

5) Which of the following statements is TRUE about a vehicle currency?

A) It is widely used to denominate contracts made by parties who reside in the country that
issues the vehicle currency.
B) The dollar is sometimes called a vehicle currency because of its pivotal role in many
foreign exchange deals.

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C) There is much skepticism that the euro will ever evolve into a vehicle currency on par
with the dollar.
D) The pound sterling, once second only to the dollar as a key international currency, is
beginning to rise in importance.
Answer: B

6) If the dollar interest rate is 10 percent, the euro interest rate is 6 percent, then
A) an investor should invest only in dollars if the expected dollar depreciation against the
euro is 4 percent.
B) an investor should invest only in euros if the expected dollar depreciation against the
euro is 4 percent.
C) an investor should be indifferent between dollars and euros if the expected dollar
depreciation against the euro is 4 percent.
D) an investor should invest only in dollars.
Answer: C

7) Which one of the following statements is the MOST accurate?

A) A rise in the interest rate offered by dollar deposits causes the dollar to appreciate.
B) A rise in the interest rate offered by dollar deposits causes the dollar to depreciate.
C) A rise in the interest rate offered by dollar deposits does not affect the U.S. dollar.
D) For a given euro interest rate and constant expected exchange rate, a rise in the interest
rate offered by dollar deposits causes the dollar to appreciate.
Answer: D

8) Which one of the following statements is the MOST accurate?

A) For a fixed interest rate, a rise in the expected future exchange rate causes a rise in the
current exchange rate.
B) For a fixed interest rate, a rise in the expected future exchange rate causes a fall in the
current exchange rate.
C) For a fixed interest rate, a rise in the expected future exchange rate does not cause a
change in the current exchange rate.
D) For a given dollar interest rate and a constant expected exchange rate, a rise in the
interest rate of the euro causes the dollar to depreciate.
Answer: A

9) Money serves as all of the following EXCEPT

A) a medium of exchange.
B) a unit of account.
C) a symbol that is made of or can be redeemed for a fixed amount of precious metal.
D) a highly liquid asset.
Answer: C

10) Which one of the following statements is the MOST accurate?

A) A rise in the average value of transactions carried out by a household or a firm causes its
demand for money to fall.
B) A reduction in the average value of transactions carried out by a household or a firm
causes its demand for money to rise.
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C) A rise in the average value of transactions carried out by a household or a firm causes its
demand for money to rise.
D) A rise in the average value of transactions carried out by a household or a firm causes its
demand for real money to rise.
Answer: D

11) For a given level of

A) nominal GNP, changes in interest rates cause movements along the L(R,Y) schedule.
B) real GNP, changes in interest rates cause a decrease of the L(R,Y) schedule.
C) real GNP, changes in interest rates cause an increase of the L(R,Y) schedule.
D) real GNP, changes in interest rates cause movements along the L(R,Y) schedule.
Answer: D

12) Given PUS and YUS

A) An increase in the European money supply causes the euro to appreciate against the
dollar, but it does not disturb the U.S. money market equilibrium.
B) An increase in the European money supply causes the euro to appreciate against the
dollar, and it creates excess demand for dollars in the U.S. money market.
C) An increase in the European money supply causes the euro to depreciate against the
dollar, and it creates excess demand for dollars in the U.S. money market.
D) An increase in the European money supply causes the euro to depreciate against the
dollar, but it does not disturb the U.S. money market equilibrium.
Answer: D

13) A permanent increase in a country's money supply

A) causes a more than proportional increase in its price level.
B) causes a less than proportional increase in its price level.
C) causes a proportional increase in its price level.
D) leaves its price level constant in long-run equilibrium.
Answer: C

14) An economy's long-run equilibrium is

A) the equilibrium that would occur if prices were perfectly flexible.
B) the equilibrium that would occur if prices were perfectly flexible and always adjusted
immediately.
C) the equilibrium that would occur if prices were perfectly flexible and always adjusted
immediately to preserve full employment.
D) the equilibrium that would occur if prices were perfectly fixed to preserve full
employment.
Answer: C

15) A change in the level of the supply of money

A) increases the long-run values of the interest rate and real output.
B) has no effect on the long-run values of the interest rate, but may affect real output.
C) has no effect on the long-run values of real output, but may affect the interest rate.
D) has no effect on the long-run values of the interest rate and real output.

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Answer: D

16) Which one of the following statements is the MOST accurate?

A) A permanent increase in a country's money supply causes a proportional long-run
depreciation of its currency against foreign currencies.
B) A permanent increase in a country's money supply causes a proportional long-run
appreciation of its currency against foreign currencies.
C) A permanent increase in a country's money supply causes a proportional short-run
depreciation of its currency against foreign currencies.
D) A permanent increase in a country's money supply causes a proportional short-run
appreciation of its currency against foreign currencies.
Answer: A

17) Which of the following statements is the MOST accurate?

A) The law of one price applies only to the general price level.
B) The law of one price applies to the general price level while PPP applies to individual
commodities.
C) The law of one price applies to individual commodities while PPP applies to both the
general price level and to individual commodities.
D) The law of one price applies to individual commodities while PPP applies to the general
price level.
Answer: D

18) In order for the condition E$/HK$ = PUS/PHK to hold, what assumptions does the
principle of purchasing power parity make?
A) Only that there are no transportation costs and restrictions on trade.
B) Only that the markets are perfectly competitive, i.e., P = MC.
C) The factors of production are identical between countries.
D) HK and the U.S. are perfectly competitive and there are no transportation costs or
restrictions on trade.
Answer: D

19) Which of the following statements is the MOST accurate?

A) In the long run, national price levels play a minor role in determining both interest rates
and the relative prices at which countries' products are traded.
B) In the long run, national price levels play a key role only in determining interest rates.
C) In the long run, national price levels play a key role only in determining the relative
prices at which countries' products are traded.
D) In the long run, national price levels play a key role in determining both interest rates
and the relative prices at which countries' products are traded.
Answer: D

20) The monetary approach makes the general prediction that

A) the exchange rate, which is the relative price of American and European money, is fully
determined in the long run by the relative supplies of those monies.
B) the exchange rate, which is the relative price of American and European money, is fully

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determined in the short run by the relative supplies of those monies and the relative
demands for them.
C) the exchange rate, which is the relative price of American and European money, is fully
determined in the short run and long run by the relative supplies of those monies and the
relative demands for them.
D) the exchange rate, which is the relative price of American and European money, is fully
determined in the long run by the relative supplies of those monies and the relative
demands for them.
Answer: D

21) When the nominal dollar interest rate ________, money demand will ________,
and the general price level will ________.
A) increases; decrease; increase
B) increases; increase; increase
C) increases; decrease; decrease
D) increases; increase; decrease
Answer: A

22) The expected rate of change in the nominal dollar/euro exchange rate is best
described as
A) the expected rate of change in the real dollar/euro exchange rate minus the U.S.-Europe
expected inflation difference.
B) the expected rate of change in the real dollar/euro exchange rate plus the U.S.-Europe
real interest rate difference.
C) the expected rate of change in the real dollar/euro exchange rate plus the U.S.-Europe
expected inflation difference.
D) the expected rate of change in the real dollar/euro exchange rate minus the U.S.-Europe
real interest rate difference.
Answer: C

23) In the long run

A) exchange rates obey relative PPP when all disturbances occur in the output markets.
B) exchange rates obey absolute PPP when all disturbances occur in the output markets.
C) exchange rates are unlikely to obey relative PPP when all disturbances occur in the
output markets.
D) exchange rates are unlikely to obey relative PPP when all disturbances are monetary in
nature.
Answer: C

24) An increase in the world relative demand for U.S. output causes
A) a short-run real depreciation of the dollar against the euro.
B) a long-run real appreciation of the dollar against the euro.
C) a long-run real depreciation of the dollar against the euro.
D) a short-run real appreciation of the euro against the dollar.
Answer: B

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 Group II

From the following 4 questions, please answer only 2. Each question is worth 4 values.

1. Suppose the dollar exchange rates of the euro and the yen are equally variable.
The euro, however, tends to depreciate unexpectedly against the dollar when
the return on the rest of your wealth is unexpectedly high, while the yen tends
to appreciate unexpectedly in the same circumstances. As a European resident,
which currency, the dollar or the yen, would be considered riskier?

Answer: The dollar and the yen have the same risk, since they both appreciate when your
wealth is unexpectedly high. The euro is less risky for you. When the rest of your
wealth falls, the euro tends to appreciate, cushioning your losses by giving you a
relatively high payoff in terms of dollars. Losses on your euro assets, on the other
hand, tend to occur when they are least painful, that is, when the rest of your wealth is
unexpectedly high. Holding the euro, therefore, reduces the variability of your total
wealth. In terms of portfolio diversification, the euro is the wisest decision and the
other two currencies have exactly the same risk.

2. In our discussion of short-run exchange rate overshooting, we assumed real

output was given. Assume instead that an increase in the money supply raises
real output in the short run. How does this affect the extent to which the
exchange rate overshoots when the money supply first increases? Is it likely
that the exchange rate undershoots?
Answer: If an increase in the money supply induces an increase in real output in the
short run, then the short-run decrease in the real interest rate will not be as
pronounced as it was without the increase in real output. In the diagram below, the
money supply rises from Ms.,1 to Ms.,2. This causes real output to rise from Y1 to
Y2 and shifts the real money demand curve out from L(R, Y1) to L(R, Y2). In the
diagram below, the resulting shifts lead to a reduction in interest rates from Rh,1 to
Rh,2, which is a smaller drop in interest rates than would have prevailed had real
money demand not shifted. (Note that it is possible that interest rates could have
actually increased if the increase in real money demand was proportionately larger
than the increase in nominal money supply. In this case, we will get exchange rate
undershooting, with the short-run exchange rate below its long-run level.) Turning
to the exchange rate diagram, two events occur. First, the drop in interest rates shifts
the return on home assets from Rh,1 to Rh,2. Second, there is a change in
expectations as people anticipate that the home currency will depreciate when home
prices rise in the future. This shifts the expected return on foreign assets from to
As a result of these shifts, the home currency depreciates from E1 to E2.
However, the drop in the value of the home currency is not as severe as it would
have been had output not increased (thus limiting the decrease in interest rates).

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In the long run, prices in the home country will rise, shifting real money supply back to its
original level and according to the text of the question, dropping output back to Y1.
This will cause interest rates to rise and, with no change in the expected return on
foreign assets, cause the exchange rate to settle in at some value between E1 and E2.
The extent of exchange rate overshooting is smaller in this scenario than when changes
in the money supply have no effect on output because the change in output limits how
large of an impact monetary policy has on real interest rates.

3. A country imposes a tariff on imports from abroad. How does this action
change the long-run real exchange rate between the home and foreign
currencies? How is the long-run nominal exchange rate affected?
Answer: Because the tariff increases foreign prices, shifts demand away from foreign
exports and toward domestic goods, the relative demand for domestic goods increases. An
increase in relative demand of domestic goods causes the value (price) of domestic goods
relative to the value (price) of foreign goods to rise, which causes a long-run real
appreciation of the domestic currency. Since there are no changes in the monetary market,
there is a long-run nominal appreciation as well.

4. Explain how the nominal euro/RMB exchange rate would be affected (all else
equal) by permanent changes in the expected rate of real appreciation of the
RMB against the euro.
Answer: A permanent increase in the expected rate of real depreciation of the euro against
the RMB leads to a permanent increase in the expected rate of depreciation of the
nominal euro/RMB exchange rate, given the differential in expected inflation rates
across China and Europe. This increase in the expected appreciation of the RMB
causes the spot rate today to depreciate.