International Monetary EconomicsProblem Set #4: Chapter 8, 9 and 10 Directions: Answer all the questions by writing on one side of each sheet of paper. Your answers should be complete, yet concise. Explain your logic and show steps; no credit will be given for answers lacking supporting calculations/discussion. Your goal should be to present a homework set that is complete and easy to grade. Turn in original hardcopies only, no Xeroxes or electronic submissions will be accepted. Please write your name (or names, if you work in a group of two). All members of the group will receive the same grade. Due date: Tuesday, November 24th, by 3:00 pm, in my office (or mailbox) or by email. I. Multiple choice questions (40 points)1. In a reserve currency system (such as the Bretton Woods system or the European ERM), currencies peg to a reserve currency. As a result:A) only the reserve currency country has monetary autonomy.B) all countries, other than the reserve currency country, have monetary autonomy.C) all countries have monetary autonomy.D) no country has monetary autonomy.2. Suppose that the U.S. price of gold is $35 per ounce and the German price of gold is 100 deutsche marks per ounce. What is the implied exchange rate between the dollar and the German deutsche mark (DM)?A) $0.35 = DM1B) $3500 = DM1C) $2.8571 = DM1D) $0.28571 = DM13. Which statement below is correct?A) The likelihood of an exchange rate crisis increases if a country is having a banking crisis.B) The likelihood of an exchange rate crisis decreases if a country is having a banking and default crisis.C) There is no relationship between an exchange rate crisis and banking or default crises.D) When a banking or default crisis occurs, countries typically are forced to appreciate their currencies.4. Changes in the domestic money supply are a result of:A) changes in the central bank’s holding of domestic credit only.B) changes in the central bank’s holding of foreign reserves only.C) some combination of changes in the central bank’s holdings of domestic credit or foreign reserves.D) changes in the nation’s stock of gold.Use the following to answer questions 5-10:SCENARIO: ARUBAN FLORINAruba pegs its currency (the Aruban florin) to the U.S. dollar at a rate of Af 1.79 = $US1. Suppose that the actual exchange rate is equal to this pegged rate.5. (Scenario: Aruban Florin) Now suppose that the Aruban central bank buys dollars. Which of the following describes the effect of this dollar purchase on Aruba’s exchange rate?A) upward pressure on the exchange rateB) downward pressure on the exchange rateC) no effect on the exchange rateD) not enough information provided6. (Scenario: Aruban Florin) Now suppose that the Aruban central bank buys dollars. Which of the following describes what will happen to Aruba’s exchange rate?A) the exchange rate will appreciateB) the exchange rate will depreciateC) the exchange rate will not changeD) not enough information provided7. (Scenario: Aruban Florin) Which of the following best describes the effect on Aruba’s money supply from purchasing dollars?A) money supply will increaseB) money supply will decreaseC) money supply will not changeD) money supply will not change as the exchange rate appreciates8. (Scenario: Aruban Florin) Which of the following best describes the effect on Aruba’s interest rates from purchasing dollars?A) Interest rates will rise.B) Interest rates will fall.C) Interest rates will not change.D) Interest rates will rise as the exchange rate depreciates.9. (Scenario: Aruban Florin) Suppose that Aruba’s money supply is Af 20 billion and Aruba’s central bank holds $10 billion of dollar reserves and Af 2.10 billion of domestic bonds. What is the backing ratio for Aruban florins?A) 10.5%B) 21%C) 50%D) 89.5%10. (Scenario: Aruban Florin) Suppose that Aruba’s money supply is Af 20 billion and Aruba’s central bank holds $10 billion of dollar reserves and Af 2.10 billion of domestic bonds. What will happen to Aruba’s backing ratio if its central bank sells $5 billion of U.S. dollars to Aruban citizens?A) It will not change.B) It will fall to 33%.C) It will fall to 42.6%.D) It will fall to 81%.Use the following to answer questions 11-13:Figure: Central Bank Balance Sheet11. (Figure: Central Bank Balance Sheet). All points on the “floating line” are so named because:A) at every point on the line, the supply of money is equal to bond holdings so that reserves are equal to zero.B) at every point above the line, the exchange rate floats.C) at every point below the line, the exchange rate is backed 100% by reserves.D) exchange rates can only float if the economy is “on” the floating line.12. (Figure: Central Bank Balance Sheet) All points on the “fixed line” (XZ) are so named because:A) at every point on the line, the supply of money is equal to bond holdings so that reserves are equal to zero.B) at every point on the line, the supply of money is greater than domestic bond holdings so that reserves are greater than zero.C) at every point to the right of the line, the money supply is backed 100% by reserves.D) exchange rates will float unless the economy is “on” the “fixed line.”13. (Figure: Central Bank Balance Sheet). When an economy with a pegged exchange rate operates with the money supply backed 100% by reserves, it is at point __________ on the diagram, and the situation is known as __________.A) Z; complete sterilizationB) B; modified fixed/floatC) M; freely floating systemD) X; currency board system14. The Maastricht Treaty, signed in 1992, initiated:A) European political integration.B) an economic and monetary union that featured a common currency.C) an alliance of nations who opposed environmental harms from trade.D) an agreement for free flow of labor and other resources across borders.15. The decision by a nation to join a currency union is based on:A) the size of the nation’s GDP.B) the diversification of its industry and population.C) the cost of designing, printing, and managing a national currency.D) the costs of abandoning a national currency versus the benefits of a common currency.16. An optimum currency union refers to the decision by a country:A) to join a monetary union that best serves its self interest.B) to join a free trade area.C) to dollarize its economy.D) to eliminate tariffs.17. Under which of the following cases is an OCA not preferred by a home country?A) The home country faces symmetric shocks with the other country.B) The labor market is well integrated, allowing for migration.C) The home country faces asymmetric shocks with the other country.D) The home economy is well integrated with the other country, carrying out vast amounts of trade.18. Denmark is not a member of the Eurozone but is a member of the ERM. What are the advantages to Denmark of not being a member of the Eurozone?A) There are none. Denmark stubbornly wants to have its own currency (the krone).B) The Danish central bank loses its monetary autonomy by not joining the Eurozone.C) There are not very many transactions between Denmark and Eurozone countries, so transactions gains from membership in the Eurozone would be small for Denmark.D) The ERM allows much more exchange rate flexibility (+/â 15%) than the Eurozone.19. In the Eurozone, labor market integration (including labor mobility) between member nations is:A) far ahead of the United States.B) on par with the United States.C) less than in the United States.D) structured differently because in the Eurozone workers have better benefits.20. The Stability and Growth Pact (SGP) of 1997:A) proposed a budgetary surveillance process.B) proposed sanctions for “excessive deficit procedure.”C) proposed signing mandatory pledges to uphold the criteria.D) proposed a budgetary surveillance process and sanctions for “excessive deficit procedure.”II. Problems and short answer questions (60%): you must show your work for credit. You will not receive credit for graphs without explanations . a. 1. (15 points) A country called Home has money demand of 100 pesos and domestic credit of 50 pesos. The central bank has no outstanding sterilization bonds.a. What must the level of reserves be?b. Suppose the central bank is forced to extend domestic credit by 45 pesos in order to bail out failing financial firms. Is the direct effect enough to induce an exchange rate crisis?c. What additional factors could push the country into an exchange rate crisis given the shock described in the previous section?2. (5 points) What purpose the nominal convergence criteria of the Maastricht Treaty serve?3. (15 points) What was Britainâs reaction to the Bundesbankâs (Germanyâs central bank) contractionary monetary policy in the 1990âs? Please describe the events and use an IS-LM-FX diagram.4. (15 points)Describe the followings:a. The Bretton Woods Systemb. Twin or triple crisesc. Sterilization5. (10 points) What is the Optimum Currency Area. What are the requirements? Give an example of a region that satisfies the OCA requirements and a region that does not satisfy the requirements.