International Monetary and Financial Economics (Daniels / Van Hoose)

Chapter 7 The International Financial Architecture and Emerging Economies

1) If an economist is talking about international institutions, governments, and NGOs and the
policies that oversee international markets, they are talking about
A) international financial architecture.
B) the role of the IMF.
C) international exchange rate regimes.
D) foreign direct investment.
Answer: A

2) The driving force behind the increase in FDI within developed economies is
A) cross-border mergers and acquisitions.
B) the international financial architecture.
C) the stabilization of international currencies.
D) the accumulation of government debt.
Answer: A

3) The two most important developments in global capital markets over the last few decades are
A) the growth in FDI within developed countries and private capital flows to emerging
economies.
B) the growth in FDI to emerging economies and private capital flows within developed
countries.
C) the growth of cross-border mergers and acquisitions and the stabilization of exchange rate
regimes.
D) the growth of cross-border mergers and acquisitions and private capital flows within
developed countries.
Answer: A

4) The financial sector of an economy includes which of the following components?

A) strengthening payment systems and regulatory agencies
B) strengthening financial sector institutions
C) attracting global capital and domestic savings
D) both A and B
Answer: D

5) Policy actions designed to allow relatively open competition in national stock and bond
markets are called
A) capital market liberalization.
B) financial sector deregulation.
C) cross-border mergers and acquisitions.
D) regulatory arbitrage.
Answer: A

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6) Asymmetric information is a form of
A) market imperfection.
B) regulatory arbitrage.
C) capital market liberalization.
D) financial sector deregulation.
Answer: A

7) Problems resulting from market imperfections include

A) adverse selection.
B) herding behavior.
C) moral hazard.
D) all of the above.
Answer: D

8) If a government implements regulations that lead firms to produce at levels of output different
from the economically efficient output, then
A) this is called policy-created distortions.
B) the IMF should be allowed to intervene.
C) the regulation suffers from asymmetric information.
D) the government should implement capital market liberalization to resolve the problem.
Answer: A

9) When firms choose to produce aboard instead of domestically, it may be the result of
A) regulatory arbitrage.
B) herding behavior.
C) moral hazard.
D) IMF intervention.
Answer: A

10) Portfolio capital flows tend to be

A) shorter term in nature.
B) part of an overall, longer term investment strategy.
C) involved in acquiring ownership positions in excess of 10%.
D) detrimental to the development of a nation's financial sector.
Answer: A

11) A legal restriction on the movement of assets denominated in foreign currencies into and out
of a nation is called
A) a capital control.
B) stabilizing FDI.
C) a private capital flow constraint.
D) a hot money flow.
Answer: A

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12) Economists believe that exchange rate regimes
A) do not come in one-size fits all.
B) are determined best by the trading partners of a nation.
C) should be dictated by a country's level of development.
D) do not interfere with discretionary monetary policy.
Answer: A

13) The theory that every nation should choose an exchange rate regime that is either completely
flexible or completely fixed is
A) known as the corners hypothesis.
B) now the standard for economic thought.
C) no longer recommended by policy makers.
D) known as dollarization.
Answer: A

14) One clear benefit of dollarization is

A) the reduction of country risk and risk premiums on interest rates.
B) the elimination of treasury responsibilities.
C) the reassurance that monetary policy is managed by experts.
D) the convenience of using the U.S. dollar for all transactions.
Answer: A

15) One clear cost of dollarization is

A) the loss of monetary policy independence.
B) the price of importing U.S. dollars to the country.
C) the inability of domestic banks to set their own interest rate structures.
D) the loss of domestic financial architecture.
Answer: A

16) The trilemma refers to the idea that

A) policy makers may choose two but not three of a set of policy options.
B) discretionary monetary policy, fixed exchange rates, and liberalized capital markets cannot
happen simultaneously.
C) if policy makers choose to have liberalized capital markets, they can either have discretionary
monetary policy or fixed exchange rates.
D) all of the above
Answer: D

17) If policy makers try to implement a flexible exchange rate, capital market liberalization, and
discretionary monetary policy, they may create a financial crisis. This problem is known as the
A) trilemma.
B) risk triangle.
C) sterilization risk.
D) financial deconstruction matrix.
Answer: A

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18) If the IMF comes back to a loan holder demanding that they implement new economic
policies, it is called
A) ex post conditionality.
B) ex ante conditionality.
C) discriminatory lending.
D) loan refinancing.
Answer: A

19) Ex post conditionality is most often accused of

A) undermining the credibility of the IMF.
B) reducing the frequency of ex ante conditionality.
C) increasing the number of country's borrowing too much money.
D) diminishing the financial longevity of the IMF.
Answer: A

20) One complaint about the World Bank is

A) that it often lends to nations that have no trouble finding private funds.
B) that it constantly implements ex post conditionality in its lending.
C) that it primarily lends to African nations when there are many other regions in need of loans.
D) that it practice of ex ante conditionality detracts from its credibility.
Answer: A

21) In the absence of adequate private lending, governments could support policies called
A) microlending.
B) hot money flows.
C) capital controls.
D) risk based capital requirements.
Answer: A

22) The HIPC initiative was designed to

A) restructure in poor countries during the 1990s.
B) supercede the Cologne Debt Initiative.
C) undo the damage caused by the Paris club.
D) replace existing capital controls in HIPC nations.
Answer: A

23) One problem of the HIPC initiative is that

A) some creditor nations were not included in the negotiations.
B) the funding can only come from member nations.
C) the heavily indebted poor countries do not want to participate.
D) the IMF and World Bank do not support the initiative.
Answer: A

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24) One economic variable that remains illusive is
A) a financial crisis indicator.
B) global debt servicing ratios.
C) the actual amount of debt owned by private banks.
D) the credit ratings of individual nations.
Answer: A

25) A mechanism for use in tracking the likelihood of a financial crisis is known as
A) an early warning system.
B) risk based capital controls.
C) an impossible variable to find.
D) exchange rate regimes indicators.
Answer: A

26) How are capital inflows and economic growth related? Discuss the role of financial
intermediaries in your answer.
Answer: Answers will vary.

27) How would ex post conditionality undermine the credibility of the IMF? What would be a
better policy and why?
Answer: Answers will vary.

28) Explain the "trilemma." Describe the three points of the problem and how they interact. What
are the implications for policy makers?
Answer: Answers will vary.

29) Capital controls are a source of controversy. Explain the pros and cons of capital controls.
Discuss how they can lead to instability and how they can assist in development.
Answer: Answers will vary.

30) How can exchange rate regimes play a role in financial crises? Consider the corners
hypothesis in your answer and describe the conditions that both extremes may play in causing a
financial crisis.
Answer: Answers will vary.

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What are the most important developments in the recent evolution of global
capital markets?
• Two important developments in the global capital markets are the growth of foreign
direct investment (FDI) among developed nations and surging private capital flows to
emerging economies.

What is the relationship between capital allocations and economic growth,

and what is the role of financial intermediaries in this relationship?
• When a nation’s financial intermediaries direct funds to the most productive investment
projects, they contribute to a higher level of real economic growth.

• Efficient financial intermediaries reduce the costs of financing investment projects, pool
risks, and reduce the impact of financial market imperfections.

• Consequently, they encourage more saving and finance more investment projects.

What is the difference between portfolio capital flows and foreign direct
investment, and what role did these capital flows play in recent financial
crises?
• Portfolio capital inflows tend to be shorter-term and more liquid than FDI.

• An excessive reliance on portfolio capital flows for financing investment projects appears
to be one of the factors that contributed to the recent financial crises in the emerging
economies, while FDI may have a stabilizing effect for the economy.

What type of exchange-rate regime is most appropriate for emerging

economies?
• Some economists argue that policymakers should commit to a hard-peg exchange-rate
regime or a fully flexible regime.

• Others argue that no single regime is appropriate for all emerging economies and that
intermediate regimes may be appropriate

• Dollarization is yet another option.

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What is the difference between FDI and FPI?