Chapter 15: Developing Countries and International Finance II: The Global Capital Flow Cycle

Multiple Choice Questions

1.Asia was the largest recipient of capital inflows, accounting for almost _____ of total flows to all developing countries in the first half of the 1990s.

a)10% b)30% c)50% d)70% e)90% Answer: c

2.According to Oatley, historical evidence suggests that more volatile capital flows have been associated with a)higher economic growth rates over the short run. b)higher economic growth rates over the long run. c)lower economic growth rates over the long run. d)lower economic growth rates over the short run. e)boom- and-bust growth rates over the long run. Answer: c

3. “Hot money” refers to a)bond and derivative funds. b)private capital that can be withdrawn at the first hint of trouble. c)public capital that cannot be easily withdrawn. d)money obtained through drugs and illegal activities. e)money hidden in secret foreign bank accounts.

Answer: b

4.Financial crises became all too common during the 1990s. Each crisis was distinctive but shared the similarities that they a)involved some form of fixed exchange rate and a heavily reliance on short-term foreign capital. b)involved some form of floating exchange rate and a heavily reliance on shortterm foreign capital. c)involved some form of fixed exchange rate and a heavily reliance on long-term foreign capital. d)involved some form of floating exchange rate and a heavily reliance on long-term foreign capital. e)involved foreign investors losing confidence in governmental commitment to exchange rate stability and less reliance on short-term foreign capital.

Answer: a

5. “Moral hazard” in the field of international political economy is when a)banks have an incentive to make safer loans than they would make in the absence of a guarantee of a government bailout. b)banks charge higher interest rates to high-risk borrowers. c)the practice of lending heavily to high-risk borrowers makes a systemic financial crisis more destructive. d)financial institutions have close ties to governments, sometimes through personal relationships. e)banks believe that the government will bail them out if they suffer large losses on the loans they have made.

Answer: e

6.Weaknesses in the Asian financial systems in the late 1990s was caused by a)appreciating currencies and popping real estate bubbles. b)depreciating currencies and popping real estate bubbles. c)appreciating currencies and real estate booms. d)international debt-service difficulties began to generate domestic debt-servicing difficulties. e)foreign banks, which had loaned heavily to Asian banks, agreeing to continue to roll over existing loans.

Answer: a

7.During the Asian financial crisis in 1997-1998, the IMF granted South Korea, Indonesia, Thailand and Malaysia a)$ 17 billion. b)$ 57 billion. c)$ 77 billion. d)$ 117 billion. e)$ 157 billion.

Answer: d a)Tightening of monetary policy to stem depreciation b)Regulation of agricultural enterprises c)Elimination of domestic monopolies d)Privatization of state-owned enterprises e)Trade liberalization

8.Which of the following conditionality agreements was not required by the IMF as part of the assistance packages in 1997-98?

Answer: b

9.A panicked withdrawal of funds from Asian markets in the summer of 1997 was due to a)deteriorating conditions in Asian financial systems and political instability. b)increasing Chinese dominance in Asian financial systems c)increasing Japanese dominance in Asian financial systems. d) deteriorating conditions in Asian financial systems and shifting international market sentiment. e) deteriorating conditions in Asian exchange markets.

Answer: d

10. East Asian governments drew one overarching lesson from the crisis and crisis management – a) do not let the economy become vulnerable to IMF intervention. b) IMF conditions reflected Japanese interests. c) IMF conditions reflected Chinese interests. d) IMF conditions reflected American interests. e) IMF discipline was necessary to control political corruption.

Answer: a

11. East Asian governments as a group accumulated more than half of global reserve holdings by then end of 2009. The country with the largest stock of foreign exchange reserves was a) Japan with $1.4 trillion. b) Indonesia with $1.4 trillion. c) S. Korea with $1.4 trillion. d) China with $2.4 trillion. e) China with $4.4 trillion.

Answer: d

12. East Asian economies have been able to run persistent current account surpluses because their governments a) pegged their currencies to the dollar at overvalued exchange rates and engaged in sterilized money supply intervention. b) pegged their currencies to the dollar at competitive exchange rates and let their money supply increase to match current account surpluses. c) pegged their currencies to the dollar at competitive exchange rates and decrease their money supply. d)pegged their currencies to the yen at undervalued exchange rates and engaged in currency speculation. e)pegged their currencies to the renminbi at competitive exchange rates and engaged in sterilized intervention.

Answer: c

13. At the end of May 2010, China owned a) 25 percent of total foreign-owned U.S. debt. b) 24 percent of total foreign-owned U.S. debt. c) 23 percent of total foreign-owned U.S. debt. d) 22 percent of total foreign-owned U.S. debt. e) 21 percent of total foreign-owned U.S. debt.

Answer: d

14.East Asian governments peg to the dollar because a)the United States is the largest economy in the world. b)the United States is their most important trade partner. c)the dollar is the international reserve currency. d)the dollar is undervalued. e)the dollar is overvalued.

Answer: b

15.The system that resulted from the arrangements that came from the IMF intervention in the East Asian financial crisis in the late 1990s has come to be called “Bretton Woods II” because a)US trade surpluses currently drive growth in East Asia, just as they drove early postwar growth in Europe. b)the system is stable as long as East Asian countries are willing to accumulate US government securities like Europeans did with U.S. gold. c)US trade deficit drives growth in East Asia, and floating exchange rate stabilize the value of the dollar. d)the system is stable as long as East Asian countries are willing to accumulate US gold like Europeans did. e)the system is still based on fixed exchange rates and IMF interventions.

Answer: b

16.The Chiang Mai Initiative was a regional body a)proposed by the Chinese as a kind of Asian Monetary Fund. b)that was enthusiastically endorsed by East Asian governments. c)proposed by the US but failed to attract support from China. d)was rejected by the Japanese who were wary of American ambitions. e)proposed by the Japanese as a kind of Asian Monetary Fund.

Answer: e

17.According to Oatley, Bretton Woods II arguably played a key role in the development of the global financial crisis of 2008-2009 because a)the demand for US government debt instruments drove up interest rates. b)high interest rates burst the real estate bubbles in US and Europe. c)the demand for US government debt instruments drove down interest rates. d)low interest rates drove down the values of commercial real estate in US and Europe. e)it undermined the Asian savings glut and US economic sovereignty.

Answer: c

18. Most of the debt of the world’s poorest countries is owed to a)official lenders like IMF & World Bank. b)resource-exporting MNCs. c)East Asian governments. d)East Asian export companies. e)oil exporting governments.

Answer: a

19.The results from the initial debt-reduction programs were disappointing. Debt-service burdens actually increased for the poorest countries in spite of reducing foreign debt by around a)$10 billion. b)$30 billion. c)$60 billion. d)$90 billion. e)$150 billion.

Answer: c

20.Eligibility for the HIPC initiative was launched in 1996 with the goal to reduce foreign debt to sustainable levels. The IMF and World Bank estimated that the typical country that completed the program would see a)its debt reduced by one quarter and its debt-service ratio cut by one third. b)its debt reduced by one half and its debt-service ratio cut in half. c)its debt reduced by one third and its debt-service ratio cut by one third. d)its debt reduced by two thirds and its debt-service ratio cut in half. e)its debt reduced by three quarters and its debt-service ratio cut by two thirds.

Answer: d

21.Asset prices began to rise rapidly in emerging market countries from 2011, generating a)fears of an emerging market housing bubble. b) hopes of a lower debt service. c) fears of political instability. d) fears of IMF interference. e) fears of rising wages.

Answer: a a)50 percent of their income after 1999 b)40 percent of their income after 1999 c)50 percent of their income after 1997 d)45 percent of their income after 1997 e)40 percent of their income after 1996

22.East Asian societies saved as much as ___________, and used an important share of these funds to purchase U.S. government securities.

Answer: c

23.The most distinctive aspect of the most recent Asian manifestation of the capital flow cycle is that a)a systemic banking but not sovereign debt crises have materialized. b) both systemic banking and sovereign debt crises have materialized. c)a systemic banking, sovereign debt crisis and political instability have materialized. d)not a systemic banking but sovereign debt crises have materialized. e) neither a systemic banking nor a sovereign debt crisis have materialized.

Answer: e

24.The volume and composition of capital flows from the advanced industrialized countries and the developing world have been shaped in large part by a)only changes in American monetary policy. b)c hanges in international financial markets and changes in American monetary policy. c) changes in international financial markets but not in American monetary policy. d) neither changes in international financial markets nor changes in American monetary policy. e) changes in the IMF and the World Bank.

Answer: b

25.International financial integration over the last 20 years has greatly expanded developing countries’ opportunities a)for attracting foreign capital. b)for restricting national capital c)for decreasing debt-service ratios d)for subsidizing agricultural exports e)for suppressing domestic dissent

Answer: a

True:-False: Questions

1. The suggestion that developing countries should reintroduce controls to limit the volume of private capital flows ultimately carried the day.

Answer: False:

2. Historical evidence suggests that more volatile capital flows have not been associated with lower economic growth rates over the long run.

Answer: False:

3. Heavy dependence on short-term capital required the continual rollover of foreign liabilities.

Answer: True:

4. The Asian financial crisis of 1997 originated in political and economic dynamics in Thailand, Indonesia, South Korea and Singapore.

Answer: False:

5. The same network of business-government relations in Asia that created the moral hazard problem in the first place also weakened the incentives that governments had to develop and enforce effective prudential regulations.

Answer: True:

6. In Indonesia, the economic crisis sparked large-scale opposition to corruption, nepotism, and cronyism that forced Suharto out of office.

Answer: True:

7. The ability for the United States to run deficits does depend, in part, on the continued willingness of the Chinese government to acquire and hold U.S. government debt.

Answer: True:

8. Bretton Woods II arguably did not play a key role in the development of the global financial crisis of 2008-2009.

Answer: False:

9. The tempers of many emerging market policymakers flared again as the Federal Reserve began to shift away from quantitative easing in the middle of 2013.

Answer: True:

10. Domestic politics influence how much foreign debt is accumulated and the uses to which it is put.

Answer: True:

Essay/Discussion Questions

1. Explain and discuss suggestions for change of the debt management regime established in the 1980s in the wake of the financial crises of the 1990s. Which of these ideas was ultimately adopted?

2. Explain how policies toward private capital flows to developing countries were radically different in the 1990s. How did these changes combine to alter the composition, as well as the scale, of private capital flows to the developing world?

3. Explain how the problem of “moral hazard” made it especially difficult for Asian banks to intermediate safely between international and domestic financial markets.

4. IMF assistance in the Asian financial crisis of the 1990s was conditional upon economic reform. What were these reforms and how did they affect Thailand and Indonesia differently?

5. Explain and discuss Bretton Woods II. How was it comparable to the original Bretton Woods system?

6. Discuss the pros and cons of China’s status as a large lender to the United States. How could China’s creditor position make it difficult to defend American interests in Asia?

7.Explain how the roots of the 2008-2009 global financial crises lie in East Asia’s governments’ responses to the 1997 crisis.

8.Discuss and analyze why global policymakers, investment banks, and media outlets were becoming increasingly concerned about the financial health of five emerging market economies India, Brazil, Turkey, South Africa, and Indonesia. What were the consequences of these concerns?

9.Explain the conditions under which the HIPC initiative developed and changed in response to the debt reduction challenges of the world’s poorest countries. Does debt cancellation encourage moral hazard dilemmas by both lenders and governments?

10.Discuss why for the developing world as a whole, the early 2000s were a period of financial stability.