AP Macro International Finance 2 — Questions and Answers
Question 1: If the U.S. dollar appreciates against the euro, what happens to U.S. exports to Europe?
- U.S. exports become cheaper for Europeans
- U.S. exports become more expensive for Europeans (Correct answer)
- U.S. exports are unaffected by exchange rate changes
- U.S. exports increase immediately
Correct answer: U.S. exports become more expensive for Europeans
A stronger dollar makes U.S. goods more expensive in foreign currency terms, reducing demand for U.S. exports.
Question 2: Which of the following would cause the U.S. current account deficit to widen?
- An increase in U.S. exports
- A decrease in U.S. consumer spending on imports
- A decrease in U.S. domestic savings relative to investment (Correct answer)
- An increase in foreign demand for U.S. goods
Correct answer: A decrease in U.S. domestic savings relative to investment
A current account deficit equals the gap between domestic investment and domestic savings; when savings fall relative to investment, the deficit widens.
Question 3: Under a fixed exchange rate system, if a country's currency is overvalued, the central bank must:
- Sell foreign currency reserves to buy domestic currency (Correct answer)
- Buy foreign currency reserves and sell domestic currency
- Raise interest rates to attract foreign investment
- Devalue the currency immediately
Correct answer: Sell foreign currency reserves to buy domestic currency
To defend an overvalued currency, the central bank sells foreign reserves and buys its own currency to maintain the fixed peg.
Question 4: The J-curve effect describes the phenomenon where a currency depreciation initially:
- Improves the trade balance before worsening it
- Worsens the trade balance before improving it (Correct answer)
- Has no effect on the trade balance in the short run
- Immediately improves the trade balance
Correct answer: Worsens the trade balance before improving it
The J-curve occurs because import/export quantities adjust slowly, so the trade balance worsens before improving after depreciation.
Question 5: If Brazil runs a capital account surplus, which of the following must be true?
- Brazil is a net lender to the rest of the world
- Brazil is experiencing a current account surplus
- Brazil is receiving more capital inflows than outflows (Correct answer)
- Brazil's exchange rate must be appreciating
Correct answer: Brazil is receiving more capital inflows than outflows
A capital account surplus means a country receives more capital investment from abroad than it sends out.
Question 6: Purchasing Power Parity (PPP) theory predicts that in the long run, exchange rates adjust so that:
- Interest rates are equal across countries
- A basket of goods costs the same in all countries when expressed in a common currency (Correct answer)
- Countries with higher inflation have appreciating currencies
- Trade balances between countries reach zero
Correct answer: A basket of goods costs the same in all countries when expressed in a common currency
PPP holds that exchange rates adjust to equalize price levels across countries when measured in a common currency.
Question 7: Which of the following best explains why a country with high inflation tends to see its currency depreciate?
- High inflation reduces interest rates, discouraging foreign investment
- High inflation erodes purchasing power, making domestic goods relatively more expensive abroad (Correct answer)
- High inflation increases exports by making goods cheaper
- High inflation attracts foreign capital seeking higher returns
Correct answer: High inflation erodes purchasing power, making domestic goods relatively more expensive abroad
Inflation erodes a currency's purchasing power, making a country's exports less competitive and causing the exchange rate to fall.
AP Macro International Finance 2
If the U.S. dollar appreciates against the euro, what happens to U.S. exports to Europe?