The International Monetary System – Chapter 11

1. The international monetary system refers to a system to regulate fixed exchange rates before the introduction of the
euro. True or False

Answer: False - The international monetary system refers to the institutional arrangements that govern exchange rates.

(True or False)

2. When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a

pegged exchange rate regime. (True or False)

Answer: False - When the foreign exchange market determines the relative value of a currency, we say that the country is
adhering to a floating exchange rate regime. Four of the world’s major trading currencies—the U.S. dollar, the European

Union’s euro, the Japanese yen, and the British pound—are all free to float against each other.

3. A pegged exchange rate means the value of the currency is fixed relative to a reference currency, and then the exchange

rate between that currency and other currencies is determined by the reference currency exchange rate. (True or False)

Answer: TRUE -Many of the world's developing nations peg their currencies, primarily to the dollar or the euro. A pegged
exchange rate means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the

exchange rate between that currency and other currencies is determined by the reference currency exchange rate.

4. As the volume of international trade expanded in the wake of the Industrial Revolution, shipping large quantities of gold

around the world to finance international trade became impractical. (True or False)

Answer: TRUE - As the volume of international trade expanded in the wake of the Industrial Revolution, a more convenient

means of financing international trade was needed. Shipping large quantities of gold and silver around the world to finance

international trade seemed impractical.

5. Under the gold standard, a country in balance-of-trade equilibrium will experience a net flow of gold from other

countries. (True or False)

Answer: FALSE - Under the gold standard, when a country has a trade surplus, there will be a net flow of gold from other

countries into that country.

6. If more dollars are needed to buy an ounce of gold than before, the implication is that the dollar is worth

more. (True or False)

Answer: FALSE - The United States returned to the gold standard in 1934, raising the dollar price of gold from $20.67 per
ounce to $35 per ounce. Because more dollars were needed to buy an ounce of gold than before, the implication was that

the dollar was worth less. This effectively amounted to a devaluation of the dollar relative to other currencies.

7. As the only currency that could be converted into gold, the British pound occupied a central place in the fixed exchange
rate system. (True or False)

Answer: FALSE - The system of fixed exchange rates established at Bretton Woods worked well until the late 1960s, when it

began to show signs of strain. As the only currency that could be converted into gold, and as the currency that served as

the reference point for all others, the dollar occupied a central place in the system.

8. The Bretton Woods system could work only as long as the U.S. inflation rate remained low and the United States did not
run a balance-of-payments deficit. (True or False)

Answer: TRUE - The Bretton Woods system could work only as long as the U.S. inflation rate remained low and the United

States did not run a balance-of-payments deficit. Once these things occurred, the fixed exchange rate system soon became

strained to the breaking point.

9. Under a floating exchange rate regime, market forces have produced a volatile dollar exchange rate. (True or False)

Answer: TRUE - In recent history, the value of the dollar has been determined by both market forces and government

intervention. Under a floating exchange rate regime, market forces have produced a volatile dollar exchange rate.

10. The disadvantage of a pegged exchange rate regime is that it aggravates inflationary pressures in a country. (True
or False)

Answer: FALSE - Under a pegged exchange rate regime, a country will peg the value of its currency to that of a major
currency so that, for example, as the U.S. dollar rises in value, its own currency rises too. Pegged exchange rates are
popular among many of the world’s smaller nations. As with a full fixed exchange rate regime, the great virtue claimed for a

pegged exchange rate is that it imposes monetary discipline on a country and leads to low inflation.

11. Some economists argue that higher inflation rates might be good if the consequence is greater growth in aggregate

demand. (True or False)

Answer: TRUE - Some economists in the International Monetary Fund are now arguing that higher inflation rates might be
a good thing, if the consequence is greater growth in aggregate demand, which would help to pull nations out of

recessionary conditions.

12. The International Monetary Fund can force countries to adopt the policies required to correct economic
mismanagement. (True or False)

Answer: FALSE - The International Monetary Fund (IMF) cannot force countries to adopt the policies required to correct

economic mismanagement. While a government may commit to taking corrective action in return for an IMF loan, internal

political problems may make it difficult for a government to act on that commitment.
13. _____ refers to a system under which the exchange rate for converting one currency into another is continuously
adjusted depending on the laws of supply and demand.

A. Fixed exchange rate

B. Floating exchange rate

C. Flexible exchange rate

D. Pegged exchange rate

E. Nominal exchange rate

B: Floating exchange rate refers to a system under which the exchange rate for converting one currency into

another is continuously adjusted depending on the laws of supply and demand. Four of the world’s major trading

currencies—the U.S. dollar, the European Union’s euro, the Japanese yen, and the British pound—are all free to
float against each other.

14. Many of the world’s developing nations peg their currencies, primarily to the _____.

A. U.S. dollar

B. Saudi riyal

C. Japanese yen

D. Chinese yuan

E. German deutsche marks

A. Many of the world’s developing nations peg their currencies, primarily to the dollar or the euro. A pegged exchange
rate means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange

rate between that currency and other currencies is determined by the reference currency exchange rate.

15. In a floating exchange rate, the relative value of a currency:

A. is more predictable and less volatile.

B. is determined by market forces.

C. changes infrequently only under a specific set of circumstances.

D. is set against other currencies at some mutually agreed on exchange rate.

E. does not depend on the free play of market forces.

B. When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a
floating exchange rate regime. Four of the world’s major trading currencies—the U.S. dollar, the European Union’s euro, the
Japanese yen, and the British pound—are all free to float against each other. Thus, their exchange rates are determined by

market forces and fluctuate against each other day to day, if not minute to minute.

16. _____ refers to a system under which a country's currency is nominally allowed to float freely against other currencies,
but in which the government will intervene, buying and selling currency, if it believes that the currency has deviated too fa r

from its fair value.

A. Fixed float

B. Clean float

C. Pegged float

D. Dirty float

E. Capital float

D. Dirty float refers to a system under which a country's currency is nominally allowed to float freely against other
currencies, but in which the government will intervene, buying and selling currency, if it believes that the currency has

deviated too far from its fair value. It is a float because in theory, the value of the currency is determined by market forces,

but it is a dirty float (as opposed to a clean float) 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 too rapidly against an important reference
currency.

17. Which of the following statements is true about the various exchange rate systems?

A. In a fixed exchange rate system, the value of a currency is adjusted according to the day to day market forces.

B. In a clean float, the central bank of a country will intervene in the foreign exchange market to try to maintain the value
of its currency.

C. After the collapse of the Bretton Woods system of floating exchange rates in 1973, the world has operated with a fixed

exchange rate system.

D. According to the Bretton Woods system, the value of most currencies in terms of U.S. dollars was allowed to change
only under a specific set of circumstances.

E. In dirty float, the exchange rate between a currency and other currencies is relatively fixed against a reference currency
 exchange rate.

D. The 1944 Bretton Woods conference established the basic framework for the post–World War II international monetary
system. The Bretton Woods system called for fixed exchange rates against the U.S. dollar. Under this fixed exchange rate

system, the value of most currencies in terms of U.S. dollars was fixed for long periods and allowed to change only under a
specific set of circumstances.

18. The ____ refers to a system to regulate fixed exchange rates before the introduction of the euro.

A. European Free Trade Association

B. European Monetary System

C. international monetary system

D. International Finance Corporation

E. European Federation of Accountants

B. Before the introduction of the euro in 1999, several member states of the European Union operated with fixed exchange

rates within the context of the European Monetary System (EMS). For a quarter of a century after World War II, the world ’s
major industrial nations participated in a fixed exchange rate system. Although this system collapsed in 1973, some still

argue that the world should attempt to reestablish it.

19. The values of a set of currencies are set against each other at some mutually agreed on exchange rate in a _____
exchange rate system.

A. clean float

B. floating

C. fixed

D. dirty float

E. pegged

C. Some countries have operated with a fixed exchange rate in which the values of a set of currencies are fixed against
each other at some mutually agreed on exchange rate.

20. The 1944 Bretton Woods conference created two major international institutions that play a role in the international
monetary system—the International Monetary Fund (IMF) and the _____.
A. United Nations

B. European Union

C. World Trade Organization

D. World Bank

E. G20

D. The 1944 Bretton Woods conference established the basic framework for the post–World War II international monetary
system. The Bretton Woods conference also created two major international institutions that play a role in the international
monetary system—the International Monetary Fund (IMF) and the World Bank. The IMF was given the task of maintaining
order in the international monetary system; the World Bank’s role was to promote development.

21. The 1944 Bretton Woods system called for _____ exchange rates against the U.S. dollar.

A. flexible

B. floating

C. fixed

D. dirty float

E. pegged

C. The 1944 Bretton Woods conference established the basic framework for the post–World War II international monetary
system. The Bretton Woods system called for fixed exchange rates against the U.S. dollar. Under this fixed exchange rate
system, the value of most currencies in terms of U.S. dollars was fixed for long periods and allowed to change only under a

specific set of circumstances.

22. Which of the following refers to the gold standard?

A. Pegging currencies to gold and guaranteeing convertibility

B. Conducting international trade by physically exchanging gold

C. The most valuable currency in the world at any given point in time
D. The common global standard of gold quality to be maintained

E. The quality of merchandise to be maintained for it to be exportable

A. Gold standard is the practice of pegging currencies to gold and guaranteeing convertibility. Given a common gold
standard, the value of any currency in units of any other currency (the exchange rate) was easy to determine.

23. Which of the following is a reason for the emergence of the gold standard?

A. Expansion in the volume of international trade due to the Industrial Revolution

B. Inability of governments to convert gold into paper currency on demand at a fixed rate

C. Widening gap between the developed and the developing nations

D. Failure of the Bretton Woods fixed exchange rate system

E. Failure of the U.S. dollar to act as a reference currency

A. As the volume of international trade expanded in the wake of the Industrial Revolution, a more convenient means of
financing international trade was needed. Shipping large quantities of gold and silver around the world to finance

international trade seemed impractical. The solution adopted was to arrange for payment in paper currency and for

governments to agree to convert the paper currency into gold on demand at a fixed rate.

24. In terms of the gold standard, the amount of currency needed to purchase one ounce of gold was referred to as the

_____.

A. gold to bond ratio

B. gold reserve ratio

C. gold mix ratio

D. gold par value

E. gold net value

D. The amount of a currency needed to purchase one ounce of gold was referred to as the gold par value. From the gold

par values of pounds and dollars, we can calculate what the exchange rate was for converting pounds into dollars.

25. A country is said to be in _____ when the income its residents earn from exports is equal to the money its residents pay

to other countries for imports.

A. a currency crisis

B. balance-of-trade equilibrium

C. balance-of-payments deficit
D. a banking crisis

E. free trade area

B. 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 account of its balance of payments is in balance).

26. Which of the following is a great strength of the gold standard?

A. It helped establish the dollar as a predominant vehicle currency.

B. It helped governments raise foreign exchange reserves thereby increasing economic stability.

C. It contained a powerful mechanism for achieving balance-of-trade equilibrium by all countries.

D. It helped reduce inflation to near-zero levels in all countries engaged in international trade.

E. It helped to establish a common currency across the globe to fund international trade.

C. The great strength claimed for 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 account of its balance

of payments is in balance).

27. In the 1930s, confidence in the _____ was shattered because countries were devaluing their currencies at will in order to

boost exports.

A. floating exchange rate system

B. gold standard system

C. fixed exchange system

D. Bretton Woods system

E. managed-float system

B. The net result of actions of countries in the 1930s was the shattering of any remaining confidence in the gold standard

system. With countries devaluing their currencies at will, one could no longer be certain how much gold a currency could
buy. Instead of holding on to another country’s currency, people often tried to change it into gold immediately, lest the
country devalue its currency in the intervening period. This put pressure on the gold reserves of various countries, forci ng
them to suspend gold convertibility.
28. Certovia and Norkland are two neighboring countries that actively trade goods and services with each other. Under the
gold standard, there will be a net flow of gold from Norkland to Certovia when:

A. Certovia is in trade deficit with Norkland.

B. Norkland is in balance-of-trade equilibrium with Certovia.

C. Certovia is in trade surplus with Norkland.

D. Certovia imports more than it exports to Norkland.

E. Norkland’s balance of payment to Certovia is favorable.

C. Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. Under the gold standard,
when country A has a trade surplus with country B, there will be a net flow of gold from country B to country A. These gold

flows automatically reduce the money supply of country B and swell country A's money supply.

29. Argonia Republic is in trade surplus with Kamboly. Under the gold standard, which of the following statements is

true until a balance-of-trade equilibrium is achieved?

A. There will be a net flow of gold from Argonia Republic to Kamboly

B. The money supply in Kamboly will reduce due to the flow of gold to Argonia Republic

C. The prices of the traded goods in Kamboly will increase

D. The demand for traded goods in Argonia Republic will increase

E. Kamboly will start to buy more goods from Argonia Republic

B. Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. Under the gold standard,
when country A has a trade surplus, there will be a net flow of gold from country B to country A. These gold flows

automatically reduce the money supply in country B and swell A’s money supply. There is a close connection between
money supply growth and price inflation. An increase in money supply will raise prices in A.

30. Which of the following was a reason that led to the collapse of the gold standard in 1939?

A. Difficulty and complexity in using the gold standard to determine the exchange rate

B. Agreement by governments to convert paper currency into gold on demand at a fixed rate

C. A cycle of competitive currency devaluations by various countries

D. Expansion in the volume of international trade in the wake of the Industrial Revolution

E. The inability of the gold standard to act as a mechanism for achieving balance-of-trade equilibrium by all countries
C. With countries devaluing their currencies at will, one could no longer be certain how much gold a currency could buy.
The net result was the shattering of any remaining confidence in the gold standard system. Instead of holding on to
another country’s currency, people often tried to change it into gold immediately, lest the country devalue its currency in

the intervening period. This put pressure on the gold reserves of various countries, forcing them to suspend gold
convertibility.

31. The objective of establishing the World Bank was to:

A. revive the gold standard.

B. promote general economic development.

C. control and manage the International Monetary Fund.

D. promote a floating exchange rate system.

E. approve large currency devaluations.

B. The agreement reached at Bretton Woods established two multinational institutions—the International Monetary Fund
(IMF) and the World Bank. The task of the IMF would be to maintain order in the international monetary system and that of

the World Bank would be to promote general economic development.

32. Which of the following observations is true of the Bretton Woods agreement?

A. The participating countries were required to exchange their currencies for gold.

B. Devaluation was accepted as a tool of competitive trade policy.

C. The agreement called for a system of floating exchange rates.

D. For weak currencies, devaluation of up to 10 percent was allowed without any formal approval by the International

Monetary Fund.

E. A fixed exchange rate system was deemed impractical.

D. An aspect of the Bretton Woods agreement was a commitment not to use devaluation as a weapon of competitive
trade policy. However, if a currency became too weak to defend, a devaluation of up to 10 percent would be allowed
without any formal approval by the IMF. Larger devaluations required International Monetary Fund approval.

33. Some economists argue that higher inflation rates might be good if the consequence is greater growth in aggregate
demand. (True or False)
Answer: TRUE - Some economists in the International Monetary Fund are now arguing that higher inflation rates might be a

good thing, if the consequence is greater growth in aggregate demand, which would help to pull nations out of

recessionary conditions.

34. All International Monetary Fund loan packages come with conditions attached. Elaborate. (5 points)

By 2012, the International Monetary Fund (IMF) was committing loans to some 52 countries that were struggling
with economic and/or currency crises. All IMF loan packages come with conditions attached. Until very recently,
the IMF has insisted on a combination of tight macroeconomic policies, including cuts in public spending, higher
interest rates, and tight monetary policy. It has also often pushed for the deregulation of sectors formerly
protected from domestic and foreign competition, privatization of state-owned assets, and better financial

reporting from the banking sector. These policies are designed to cool overheated economies by reining in
inflation and reducing government spending and debt. This set of policy prescriptions has come in for tough
criticisms from many observers, and the IMF itself has started to change its approach.