1.) The gravity model predicts that the value of trade between two countries ---
ID: 1115507 • Letter: 1
Question
1.) The gravity model predicts that the value of trade between two countries ---- with the size of their GDPs and ---- with the distance between them.
A
increases; increases
B
increases; decreases
C
decreases; increases
D
decreases; decreases
2.) A country with a floating exchange rate faces a short-run recession and current account deficit. Policymakers want to use temporary expansionary monetary policy to increase both output and the current account balance. Will they be successful?
A
Yes, with both problems
B
Only with increasing output
C
Only with increasing the current account balance
D
No, not with either problem
3.)
The Federal Reserve could offset an appreciation of the dollar against the yen by
A
increasing the money supply, which promotes falling interest rates and net capital outflows.
B
increasing the money supply, which promotes rising interest rates and net capital inflows.
C
decreasing the money supply, which promotes falling interest rates and net capital outflows.
D
decreasing the money supply, which promotes rising interest rates and net capital inflows.
4.)
Under a fixed exchange rate regime, expansionary fiscal policy would ---- interest rates and GDP, which would cause the exchange rate to ----, forcing the central bank to undertake ---- monetary policy.
A
raise; appreciate; expansionary
B
lower; depreciate; contractionary
C
raise; depreciate; contractionary
D
lower; appreciate; expansionary
5.)
Consider an economy with a fixed exchange rate and free flows of capital. If it wants to lower inflation, then
A
expansionary monetary policy will be effective.
B
contractionary monetary policy will be effective.
C
monetary policy will be ineffective.
6.)
Suppose a fixed exchange rate regime based on a reserve currency is in place across all countries. With free capital flows, who has monetary policy independence?
A
All countries
B
No country
C
The country whose currency is held as reserves
D
All countries other than the country whose currency is held as reserves
Explanation / Answer
1) The right answer is option B. increases; decreases
Explanation: The gravity model of trade uses the concept of gravity from science. In science, the gravity of two objects increases with their size (i.e. mass) and decreases with the distance between the objects. Similarly, the gravity model in trade states that the volume of trade between two countries increases with the size of their economy (measured by GDP) and the distance between the two countries.
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