CBE Macroeconomics 3 — Questions and Answers
Question 1: Under a fixed exchange rate regime, a country experiencing a balance of payments deficit must:
- Raise tariffs to restrict imports
- Use foreign reserves to defend the peg (Correct answer)
- Allow the currency to depreciate
- Increase the money supply
Correct answer: Use foreign reserves to defend the peg
To maintain a fixed rate when demand for the currency falls, the central bank must sell foreign reserves to buy its own currency and support the peg.
Question 2: The Solow growth model predicts that, holding other factors constant, poorer countries will grow faster than richer ones. This is called:
- Divergence hypothesis
- Conditional convergence
- Absolute convergence (Correct answer)
- Endogenous growth
Correct answer: Absolute convergence
Absolute (unconditional) convergence predicts that all economies converge to the same steady state due to diminishing returns to capital, so poorer nations grow faster.
Question 3: Which of the following best describes 'crowding out' in fiscal policy?
- Government deficits reduce private investment by raising interest rates (Correct answer)
- Tax cuts increase consumer spending too much
- Monetary expansion offsets fiscal stimulus
- Trade deficits reduce domestic output
Correct answer: Government deficits reduce private investment by raising interest rates
Crowding out occurs when government borrowing raises real interest rates, making private investment more expensive and thus reducing it.
Question 4: The velocity of money in the quantity theory equation (MV = PQ) represents:
- The speed at which the Fed prints money
- The average number of times a dollar is spent in a period (Correct answer)
- The ratio of nominal to real GDP
- The inflation rate divided by the growth rate
Correct answer: The average number of times a dollar is spent in a period
Velocity (V) measures how frequently the average dollar changes hands in transactions within a given time period.
Question 5: If a country's current account is in deficit, which must be true by definition?
- The trade balance is in surplus
- The capital and financial account is in surplus (Correct answer)
- Foreign direct investment is negative
- The budget deficit equals the current account deficit
Correct answer: The capital and financial account is in surplus
By the balance of payments accounting identity, a current account deficit must be exactly offset by a capital and financial account surplus.
Question 6: The concept of 'rational expectations' in macroeconomics implies that:
- People always make correct predictions about the future
- Agents use all available information efficiently when forming expectations (Correct answer)
- Expectations are adaptive and based only on past data
- Monetary policy is always effective
Correct answer: Agents use all available information efficiently when forming expectations
Rational expectations theory holds that agents use all available information optimally, not that they are perfect forecasters—they just don't make systematic errors.
Question 7: Which of the following scenarios would shift the aggregate supply curve to the right?
- A rise in oil prices
- An increase in government spending
- Technological improvement increasing productivity (Correct answer)
- A decrease in the labor force
Correct answer: Technological improvement increasing productivity
Technological progress lowers production costs and expands productive capacity, shifting the long-run and short-run aggregate supply curves rightward.
CBE Macroeconomics 3
Under a fixed exchange rate regime, a country experiencing a balance of payments deficit must: