Ch10 The Determination of Exchange Rates.docx

International Business Chapter 10 The Determination of Exchange Rates 1) The primary objective of the International Monetary Fund is to ________. A) encourage euro adoption B) promote exchange rate stability C) establish a unilateral system of payments D) foster the power of the foreign exchange market Answer: B Learning Outcome: Summarize the roles of the international monetary system and global capital market 2) The Bretton Woods Agreement established a system of fixed exchange rates under which each IMF member country set a ________. A) quota B) par value C) gold standard D) nominal interest rate Answer: B Learning Outcome: Summarize the roles of the international monetary system and global capital market 3) In order to join the IMF, a country must contribute a certain sum of money, called a ________. A) special drawing right B) trade balance C) monetary reserve D) quota Answer: D Learning Outcome: Summarize the roles of the international monetary system and global capital market 4) Which of the following best describes the special drawing right? A) an international reserve asset created to supplement members' existing reserve assets B) the official currency for international trade established by the World Bank C) a substitute for the fixed value of gold as determined by currency rates D) a contribution made by countries to join the IMF Answer: A Learning Outcome: Summarize the roles of the international monetary system and global capital market 5) The value of the SDR is currently based on the ________. A) euro B) U.S. dollar C) weighted average of four currencies D) weighted average of six currencies Answer: C Learning Outcome: Summarize the roles of the international monetary system and global capital market 6) What role has the IMF played in the Greek financial crisis of 2010-2011? A) setting the value of the drachma B) releasing funds for debt payments C) demanding the sale of state-owned assets D) lowering interest rates for international investors Answer: B Learning Outcome: Summarize the roles of the international monetary system and global capital market 7) Which of the following was NOT a result of the Smithsonian Agreement? A) revaluation of currencies other than the dollar against gold B) establishment of par values the quota system C) devaluation of the dollar against gold D) widening of exchange-rate flexibility Answer: B Learning Outcome: Summarize the roles of the international monetary system and global capital market 8) The primary result of the Jamaica Agreement was to ________. A) allow greater exchange-rate flexibility B) set austerity measures for debt control C) establish a system based on par values D) implement fixed exchange rates Answer: A Learning Outcome: Summarize the roles of the international monetary system and global capital market 9) ________ is a form of locking the value of a country's currency onto another currency. A) Managed floating B) Monetarization C) Dollarization D) Floating Answer: C 10) Which type of exchange rate arrangement is based on supply and demand? A) soft peg B) hard peg C) crawling D) floating Answer: D 11) Which of the following countries has a soft peg currency? A) China B) Brazil C) Japan D) India Answer: A 12) Which of the following was part of the stability and growth pact that was required for countries to be part of the European Monetary Union? A) The annual government budget must be no greater than 3% of GDP. B) The annual inflation rate must remain within 1.5% of the three best-performing EU countries. C) The annual government budget deficit could be no greater than 60% of GDP. D) The annual inflation rate must remain within 5.5% of the four best-performing EU countries. Answer: B 13) Which EU country has NOT adopted the euro? A) Germany B) France C) Sweden D) Greece Answer: C 14) The major objective of the European Central Bank is to ________. A) set monetary policy for EU countries that adopt the euro B) ensure that EU interest rates are equal to U.S. rates C) control taxes as a means of monitoring EU debt D) reduce spending by EU countries Answer: A 15) Which of the following problems with the euro most likely worsened the financial crisis in Greece? A) excessive flexibility with interest rates B) cultural disagreements on labor reform C) lack of uniform fiscal regulation standards D) unclear policies of the European Central Bank Answer: C 16) Which of the following has the greatest amount of foreign-exchange reserves in the world? A) China B) Japan C) Russia D) Taiwan Answer: A 17) The global financial crisis has pushed China closer to ________. A) operating independently from the central banks of other countries B) discontinuing its relationship with the Bank for International Settlements C) liberalizing its currency D) controlling its currency Answer: C 18) Why is China most likely considering a greater reliance on the SDR? A) gains in the foreign exchange market B) concerns about the value of the U.S. dollars C) demands to replace the dollar with the euro for reserves D) requirements by the IMF to make China's currency more flexible Answer: B 19) Which of the following links together the central banks of the world and acts as a central banker's bank? A) the IMF B) the World Bank C) the BIS D) the EMU Answer: C 20) If inflation in the United States is relatively higher than inflation in Japan, and the Japanese government wants to keep the exchange rate fixed between the yen and the dollar, it should most likely ________. A) allow its currency to rise against the dollar B) allow its currency to fall against the dollar C) increase the supply of yen in the market D) decrease the supply of yen in the market Answer: C 21) Given the daily volume of foreign-exchange transactions, it is most accurate to say which of the following? A) It is impossible for a government's interventions in the foreign-exchange market to affect market psychology. B) A government's intervention in the foreign-exchange market can reverse a currency's slide for the long term. C) A government's intervention cannot force the foreign-exchange market to move in a direction it doesn't want to go. D) A government should focus more on intervening in foreign-exchange markets than on correcting economic fundamentals. Answer: C Learning Outcome: Discuss arguments for and against government intervention in international business 22) A country's central bank is responsible for ________. A) distributing money to foreign countries that are in a debt crisis B) encouraging disorderly conditions in foreign exchange markets C) the policies affecting the value of its country's currency D) establishing foreign exchange markets Answer: C 23) The central bank in the United States is the ________. A) Federal Reserve System B) U.S. Exchange Reserve C) Board of Governors D) U.S. Treasury Answer: A 24) The ________ is the currency most widely used as a reserve asset. A) euro B) Japanese yen C) U.S. dollar D) British pound Answer: C 25) The Fed wants to counter downward pressure on the dollar, so it will most likely ________. A) sell dollars for foreign currency B) sell dollars and buy foreign stocks C) buy Treasury bills with dollars D) buy dollars with foreign currency Answer: D 26) A black market exists when ________. A) a country closely monitors and adjusts the foreign-exchange rate B) people pay more for hard currency than the official rate C) a country is running a budget surplus D) a country is experiencing a recession Answer: B 27) Hard currencies are usually ________. A) not fully convertible B) undesirable assets C) highly liquid D) unstable Answer: C 28) Fully convertible currencies are also called ________. A) external currencies B) hard currencies C) unlimited currencies D) soft currencies Answer: B 29) Governments use a multiple exchange rate system to ________. A) increase their budget surplus B) reduce exports C) control foreign exchange convertibility D) limit deposit requirements Answer: C 30) Country X has a floating rate for luxury goods and a lower rate for semi-manufactured goods. Which of the following is most likely used by Country X? A) import deposit requirements B) multiple exchange-rates C) import licensing D) quantity controls Answer: B 31) Thomas is planning a vacation to Country X. On a tourism Web site, he reads that the government of Country X limits the amount of money a tourist may convert into the country's currency. Country X most likely uses which of the following? A) import deposit requirements B) multiple exchange rates C) import licensing D) quantity controls Answer: D 32) The purchasing power parity theory claims that a change in relative ________ between two countries must cause a change in ________ in order to keep the prices of goods in two countries fairly similar. A) exchange rates; inflation B) inflation; exchange rates C) interest rates; inflation D) interest rates; exchange rates Answer: B 33) The ________ theory seeks to define the relationship between currencies based on relative inflation. A) inflation growth rate B) revaluation C) purchasing power parity D) interest rate Answer: C 34) According to purchasing power parity theory, if Brazilian inflation was 6 percent and inflation in Argentina was 12 percent, the Brazilian real would be expected to ________. A) rise by the difference in inflation rates B) fall by the difference in inflation rates C) rise by 4.5 percent D) stay the same Answer: A 35) Which of the following is used as an illustration of the PPP theory for estimating exchange rates? A) the Composition of Official Foreign Exchange Reserves (COFER) B) the black market rate C) the import licensing ratio D) the Big Mac Index Answer: D 36) Which of the following statements best describes a limitation of the Big Mac Index? A) Profit margins vary by the strength of competition, which affect relative prices. B) The theory of PPP incorrectly assumes that there are barriers to trade. C) The Big Mac represents all possible commodities and services. D) Taxes have no effect on Big Mac prices. Answer: A 37) According to purchasing power parity, if the domestic inflation rate is ________ than that in the foreign country, the domestic currency should be ________ than that of the foreign country. A) lower; weaker B) higher; higher C) lower; stronger D) higher; stronger Answer: C 38) If a Big Mac costs $3.41 in the United States and $2.67 in Argentina (the price of a Big Mac in Argentine pesos converted into dollars at the spot exchange rate), which of the following is most likely true? A) The peso is overvalued against the dollar. B) The dollar is overvalued against the peso. C) It should be harder for a U.S. tourist to buy a leather coat in Buenos Aires because the dollar won't go very far. D) It will be cheap for Argentine companies to invest in the United States because the dollar is relatively weak. Answer: B 39) Which of the following states that the country with the higher interest rate should have the higher inflation? A) the Fisher Effect B) the International Fisher Effect C) the Interest Rate Inflation Theory D) the Forward rate theory Answer: A 40) The International Fisher Effect ________. A) links interest rates and inflation B) implies that the currency of the country with the lower interest rate will weaken in the future C) implies that the country with the higher interest rate should have lower inflation D) links interest rates and exchange rates Answer: D Learning Outcome: Summarize the roles of the international monetary system and global capital market 41) The International Fisher Effect implies that ________ A) the country with the higher interest rate should have lower inflation B) the currency of the country with the lower interest rate will strengthen in the future C) the currency of the country with the higher interest rate will strengthen in the future D) interest rates and inflation are not linked at all Answer: B Learning Outcome: Summarize the roles of the international monetary system and global capital market 42) If the real interest rate is 5%, the rate of inflation in the United States is 6%, and the rate of inflation in the United Kingdom is 3%, which of the following statements would NOT be true? A) The nominal rate of interest in the U.S. would be greater than the nominal interest rate in the U.K. B) The difference between the U.K. and U.S. interest rates is a function of the difference between their inflation rates. C) The nominal rate of interest in the United States and the United Kingdom would be the same because of purchasing power parity. D) Investors would get a higher return on their money in the United States. Answer: C 43) Ted, a manager at Global Manufacturing, is analyzing trends in economic variables to predict future exchange rates that might affect the MNEs international operations. Which of the following is Ted most likely doing? A) fundamental forecasting B) technical forecasting C) resource forecasting D) economic forecasting Answer: A 44) Sarah, a manager at Farley Enterprises, an MNE with operations in Asia, Europe, and North America, is using past trends in exchange rate movements to spot future trends. Which type of forecasting approach is Sarah most likely using? A) fundamental B) technical C) application D) economic Answer: B 45) A technical forecaster is also known as a ________. A) CFO B) de facto economist C) chartist D) monetary administrator Answer: C 46) Research has shown that past exchange rates are an accurate predictor of future exchange rates ________. A) only in the long run B) only in the very short run C) only during times of economic crisis D) only during times of economic calm Answer: B 47) Forecasters must predict the magnitude, direction, and ________ of an exchange rate change or movement. A) length B) timing C) altitude D) depth Answer: B 48) It is easier to predict the ________ of a change than the ________ of a change in exchange rates. A) altitude; magnitude B) depth; length C) timing; depth D) direction; magnitude Answer: D 49) In a country with a currency that is not freely floating, the timing of an exchange rate change is often a ________ decision. A) cultural B) consensus C) political D) market Answer: C 50) Many economists have predicted that Hong Kong will change its currency system to the ________. A) U.S. dollar B) euro C) yuan D) won Answer: C 51) Shelly, a manager at a global firm, is studying the foreign currency intervention practices of Indonesia. Shelly is most likely examining ________ factors. A) institutional setting B) fundamental analysis C) confidence D) circumstantial Answer: A 52) Craig, a manager at a global firm, is studying the cyclical nature of growth and employment as a part of the process to forecast exchange rates. Which factor is Craig most likely monitoring? A) the institutional setting B) fundamental analyses C) cultural analyses D) circumstances Answer: B 53) Tanya is a manager at a global firm that has operations located in Brazil, India, and Japan. Tanya is in the process of making a fundamental analysis in order to forecast exchange rates in each country. Which of the following questions is most relevant to Tanya? A) What is the cyclical situation in terms of employment and inflation? B) Are the government's intervention practices sustainable? C) What level of credibility does the government have? D) What is the possibility of a national crisis? Answer: A 54) Tanya is a manager at a global firm that has operations located in Brazil, India, and Japan. Tanya is in the process of making a fundamental analysis in order to forecast exchange rates in each country. Which of the following is a confidence factor that Tanya should consider in trying to predict exchange rate movements in each country? A) What are the expectations of the market with respect to the political environment? B) Have there been significant national events that have appeared in the news lately? C) At what rates do there appear to be buy and sell orders? D) What trends do the charts show? Answer: A 55) Ray, a marketer at a global firm, monitors the exchange rate of countries in which the firm sells its products. Ray is most likely concerned about changes in ________. A) operating expenses B) exporting policies C) product demand D) quality control Answer: C 56) Which of the following accurately explains how producers are affected by exchange rate changes? A) To save money, a manufacturer may decide to relocate production to a country with a stronger currency. B) A manufacturing firm relocating to a country with a weak currency can make a cheap initial investment. C) Goods manufactured in a country with a weak currency may be relatively expensive in world markets. D) A manufacturer with high operating expenses would likely relocate production to a country with a currency that is gaining value. Answer: B Learning Outcome: Summarize the roles of the international monetary system and global capital market 57) If the euro continues to remain strong against the U.S. dollar, which of the following strategies would make the most sense for BMW? A) It might be advantageous for them to consider exporting from Germany to the U.S. to take advantage of cheaper costs. B) It might increase its manufacturing capacity in the United States to take advantage of the cheaper dollar. C) It might consider raising prices in the United States to earn more profits for BMW. D) It really doesn't make any difference to BMW since consumers will buy the cars no matter what they cost. Answer: B 58) Endaka, the "high yen," caused financial problems for ________. A) Japanese foreign-exchange reserves B) American foreign-exchange reserves C) Japanese importers D) Japanese exporters Answer: D 59) Which of the following most accurately describes the economic situation in El Salvador? A) It is facing significant competition from neighboring countries that are not tied to the dollar. B) It relies exclusively on the United States as a market for its products. C) It now has the same exchange rate as other members of CACM. D) It is putting more resources into industries that have a history of earning profits. Answer: A 60) According to the text, which currency is expected to experience the most change in the upcoming years? A) yen B) yuan C) euro D) U.S. dollar Answer: B 61) The IMF's primary role is to identify exchange rate regimes. Answer: FALSE Learning Outcome: Summarize the roles of the international monetary system and global capital market 62) The SDR is equal in value to the U.S. dollar. Answer: FALSE 63) Dollarization of a currency occurs when a country takes all of its own currency out of circulation and replaces it with U.S. dollars. Answer: TRUE 64) An independently floating exchange rate is adjusted periodically at a fixed pronounced rate. Answer: FALSE 65) None of the new members of the EU has yet been allowed to adopt the euro as its currency. Answer: FALSE 66) The major objective of the European Central Bank is to control taxes as a means of deficit spending. Answer: FALSE 67) According to the Treaty of Maastricht, a euro applicant must have a total outstanding government debt that does not exceed 60% of its GDP. Answer: TRUE 68) Inflation in the United States would cause China's massive dollar reserves to lose value. Answer: TRUE 69) Demand for a country's independently floating currency is a function of the demand for that country's goods, services, and financial assets. Answer: TRUE 70) A currency that is pegged to another currency is usually changed on a supply-and-demand basis. Answer: FALSE 71) Central bank reserve assets are kept in three major forms: foreign-exchange reserves, silver, and gold. Answer: FALSE 72) Although central banks are responsible for foreign exchange policy, they have no power to intervene in exchange rate markets. Answer: FALSE 73) The Japanese yen is an example of a soft currency. Answer: FALSE 74) In a multiple exchange-rate system, the government determines which kinds of transactions are to be conducted at which exchange rate. Answer: TRUE 75) According to the purchasing power parity theory, a change in relative interest rates between two countries must cause a change in exchange rates. Answer: FALSE 76) Purchasing power parity (PPP) is a well-known theory that seeks to define relationships between currencies. Answer: TRUE 77) The Big Mac Index perfectly explains the relative size of economies. Answer: FALSE 78) The Big Mac Index suggests that exchange rates should leave Big Mac hamburgers costing the same in the U.S. as abroad. Answer: TRUE 79) The International Fisher Effect links interest rates and exchange rates. Answer: TRUE Learning Outcome: Summarize the roles of the international monetary system and global capital market 80) The International Fisher Effect implies that the country with the higher interest rate should have lower inflation. Answer: FALSE Learning Outcome: Summarize the roles of the international monetary system and global capital market 81) Fundamental forecasters assume that if current exchange rates reflect all facts in the market, then under similar circumstances, future rates will follow the same patterns. Answer: FALSE 82) Fundamental forecasting uses trends in economic variables to predict future rates. Answer: TRUE 83) The three variables predicted by forecasting are the timing, magnitude, and length of exchange rate movements. Answer: FALSE 84) When forecasting exchange rates, forecasters must predict the magnitude, timing, and direction of change in exchange rates. Answer: TRUE 85) Technical forecasting relies on trends in economic variables to predict future exchange rates. Answer: FALSE 86) A current account deficit suggests that a country is importing more than it is exporting and building up foreign debt. Answer: TRUE 87) An MNE would most likely benefit from converting local currency into its home-country currency when exchange rates are most favorable so it can maximize its return. Answer: TRUE 88) Producers are affected by exchange rate changes because goods manufactured in a country with a weak currency will be relatively cheap in world markets. Answer: TRUE 89) The IMF uses the quota system to determine how much a country may borrow from the Fund. Answer: TRUE Learning Outcome: Summarize the roles of the international monetary system and global capital market 90) El Salvador's hard peg exchange rate arrangement involves the use of both the U.S. dollar and its own separate legal tender. Answer: FALSE 91) What is the International Monetary Fund (IMF)? What are its objectives? What occurs when a country joins the IMF today? Answer: In 1944, toward the close of World War II, the major allied governments met in Bretton Woods, New Hampshire, to determine what was needed to bring economic stability and growth to the postwar world. Twenty-nine countries initially signed the IMF agreement. There were 186 member countries by 2009. The IMF's major objectives are: a. to promote international monetary cooperation b. to foster economic growth and high levels of employment c. to promote exchange rate stability d. to make its resources available to its members experiencing balance of payment difficulties. When a country joins the IMF, it contributes a certain sum of money, called a quota, broadly based on its relative size in the global economy. The IMF can draw on this pool of money to lend to countries, and it uses the quota as the basis of how much a country can borrow from the Fund. Learning Outcome: Summarize the roles of the international monetary system and global capital market 92) What is a Special Drawing Right (SDR)? How is it used? Answer: To help increase international reserves, the IMF created the special drawing right (SDR) in 1969 to help reinforce the fixed exchange-rate system that existed at that time. To support its currency in foreign-exchange markets, a country could use only U.S. dollars or gold to buy currency. However, because of the lack of sufficient gold and dollars, the SDR could provide member countries with instant reserve assets, thereby expanding global liquidity. Thus, the SDR is an international reserve asset created to supplement members' official holdings of gold, foreign exchange, and IMF reserve positions. Serving as the IMF's unit of account—the unit in which the IMF keeps its records—SDRs are used for IMF transactions and operations. Learning Outcome: Summarize the roles of the international monetary system and global capital market 93) Describe the exchange rate arrangements used in the EU, Hong Kong, China, and the U.S. Answer: The EU uses an exchange arrangement with no separate legal tender. The currency of another country circulates as the sole legal tender or the member belongs to a monetary or currency union in which the members of the union share the same legal tender. Hong Kong uses a currency board arrangement. A currency board is an organization in a country that is generally separate from a country's central bank and which issues currency based on the amount of particular foreign currency that it has on deposit. The Chinese yuan fits in the soft peg category, more specifically in the stabilized arrangement, which means that the exchange rate remains within a margin of 2 percent against its anchor, which used to be the dollar and is now a basket of currency. The U.S. dollar independently floats, which means that the exchange rate is market determined, with any intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it. Learning Outcome: Summarize the roles of the international monetary system and global capital market , 3 94) In a short essay, compare the roles of the Federal Reserve Bank of New York and the European Central Bank. Answer: The central bank in the United States is the Federal Reserve System (the Fed), a system of 12 regional banks. The New York Fed, representing the Federal Reserve System and the U.S. Treasury, is responsible for intervening in foreign exchange markets to achieve dollar exchange rate policy objectives and to counter disorderly conditions in foreign exchange markets. It makes such transactions in close coordination with the U.S. Treasury and Board of Governors of the Fed, and most often coordinates with the foreign exchange operations of other central banks. The Federal Reserve Bank of New York serves as fiscal agent in the United States for foreign central banks and official international financial organizations. It acts as the primary contact with other foreign central banks. In the European Union, the European Central Bank coordinates the activities of each member country's central bank to establish a common monetary policy in Europe, much as the Federal Reserve Bank does in the United States. Learning Outcome: Summarize the roles of the international monetary system and global capital market , 3 95) What is a black market? Under what conditions might one exist? Answer: In many countries that control their currencies fairly rigidly, a black market parallels the official market and is aligned more closely with the forces of supply and demand than is the official market. The less flexible a country's exchange rate arrangement, the more likely there will be a thriving black market. A black market exists when people are willing to pay more for dollars than the official rate. The movement of floating regimes eliminates the need for a black market. Learning Outcome: Summarize the roles of the international monetary system and global capital market 96) In a short essay, discuss purchasing power parity and the short-run problems that affect PPP. Answer: Purchasing power parity (PPP) is a well-known theory that seeks to define relationships between currencies. It claims that a change in relative inflation between two countries must cause a change in exchange rates to keep the prices of goods in two countries fairly similar. According to the PPP theory, if, for example, Japanese inflation were 2 percent and U.S. inflation were 3.5 percent, the dollar would be expected to fall by the difference in inflation rates. Then the dollar would be worth fewer yen than before the adjustment, and the yen would be worth more dollars than before the adjustment. The short-run problems that affect PPP and the "Big Mac" Index include: a. the theory of PPP falsely assumes that there are no barriers to trade and that transportation costs are zero; b. the prices in different countries are distorted by taxes; c. the Big Mac is not just a basket of commodities; its price includes nontraded costs such as rent, insurance, and so on; and d. profit margins vary by the strength of competition; the higher the competition, the lower the profit margin and therefore the price. Learning Outcome: Summarize the roles of the international monetary system and global capital market 97) What methods are used by managers to forecast exchange rates? What are the main factors that influence exchange rates? Answer: Fundamental forecasting uses trends in economic variables to predict future rates. The data can be plugged into an econometric model or evaluated on a more subjective basis. On the other hand, technical forecasting uses past trends in exchange rates themselves to spot future trends in rates. Technical forecasters, or chartists, assume that if current exchange rates reflect all facts in the market, then under similar circumstances future rates will follow the same patterns. Research has shown that technical forecasting is not very accurate except in the very short run. Some factors that determine exchange rates are purchasing power parity (relative rates of inflation), differences in real interest rates (nominal interest rates reduced by the amount of inflation), confidence in the government's ability to manage the political and economic environment, and certain technical factors that result from trading. Learning Outcome: Summarize the roles of the international monetary system and global capital market , 5 98) How do exchange rate changes affect a company's marketing, production, and financial decisions? What predictors should a manager monitor to forecast exchange rate changes? Answer: Marketing managers watch exchange rates because they can affect demand for a company's product at home and abroad. Exchange rate changes affect production decisions. For example, a manufacturer in a country where wages and operating expenses are high might be tempted to locate production in a country with a currency that is rapidly losing value. The company's currency would buy a significant amount of the weak currency, making the company's initial investment cheaper. Furthermore, goods manufactured in that country would be relatively cheap in world markets. Exchange rates can affect financial decisions, primarily in the areas of sourcing of financial resources, remittance of funds across national borders, and reporting of financial results. In general, the best predictors of future exchange rates are interest rates for short-term movements, inflation for medium-term movements, and current account balances for long-term movements. Managers can also monitor a government's institutional setting, fundamental analyses, confidence factors, circumstances, and trends. Learning Outcome: Summarize the roles of the international monetary system and global capital market , 6 99) What led to the Greek financial crisis of 2010? What have been the roles of the IMF and European Central Bank in the crisis? What challenges with the euro facilitated the crisis? Answer: The IMF has played an important role in the Greek financial crisis that unfolded in 2010 and 2011. Greece, a member of the European Union, has adopted the euro as its currency and thus has no control over monetary policy. Interest rates are set by the European Central Bank. But Greece has piled up huge sovereign debt that exceeds 160 percent of GDP, largely to other banks in Europe. The Greek economy is in recession, the public sector generates 40 percent of the economy and 25 percent of the workforce, and the government keeps piling up budget deficits. In order to keep the government from defaulting on its debt, the IMF partnered with the European Union and the European Central Bank to provide loans to Greece on the condition that it would take severe austerity measures to solve its budget crisis, including raising taxes, cutting spending, and selling off state-owned assets. One of the ongoing challenges for the euro is the lack of uniform standards of fiscal regulation among member nations, which allows nations like Greece or Portugal to spend well beyond their budgets to support their welfare systems with few actual checks from the European Central Bank. Learning Outcome: Summarize the roles of the international monetary system and global capital market , 3 100) What are the main arguments for and against Africa developing a common currency like the EU? Answer: A major advantage of establishing a central bank and common currency in Africa is that institutions in each African nation will have to improve, and the central bank may be able to insulate the monetary policy from political pressures, which often create inflationary pressures and subsequent devaluations. Critics argue that the institutional framework in the individual African nations is simply not ready. Few of the individual central banks are independent of the political process, so they often have to stimulate the economy to respond to political pressures. If the process is not managed properly and the currency is subject to frequent devaluation, there will be no pride in the region or clout on the international stage. Further, each country will have to give up monetary sovereignty and rely on other measures, such as labor mobility, wage and price flexibility, and fiscal transfers, to weather the shocks. Even though there is good labor mobility in Africa, it is difficult to imagine that the African countries will be able to transfer tax revenues from country to country to help stimulate growth. In addition, it is difficult to transfer goods among the different countries in Africa because of transportation problems.