Ch 17

Describe some buyers and some sellers in the market for U.S. dollars.

- buyers: U.S. export firms that want to convert their earnings across seas back into U.S. dollars; foreign tourists in the United States; and foreign investors seeking to make financial investments in the U.S. economy - sellers: foreign firms that have sold imported goods and services into the U.S. that want to convert their earnings back to their home currency; U.S. tourists abroad; U.S. investors seeking to make financial investments in foreign economies

What's the difference between a floating exchange rate, a soft peg, a hard peg, and dollarization?

- floating exchange rate is when a country lets the value of its currency be determined in the exchange rate market - a soft peg is an exchange rate policy where the government usually allows the exchange rate to be set by the market, but in some cases, especially if the exchange rate seems to be moving rapidly in one direction, the central bank will intervene - a hard peg is an exchange rate policy in which the central bank sets a fixed and only rarely changing value for the exchange rate - dollarization is when a country that is not the United States uses the U.S. dollar as its currency

What are some of the reasons a central bank is likely to care, at least to some extent, about the exchange rate?

- movements in the exchange rate will affect the quantity of aggregate demand in an economy - frequent substantial fluctuations in the exchange rate can disrupt international trade and cause problems in a nation's banking system (unsustainable balance of trade and large inflows of international financial capital)

A stronger euro is less favorable for:

American tourists traveling in France

If the U.S. dollar weakens, which of the following parties will benefit?

U.S. firms selling in Europe

If government policy allows a country's currency to be determined in the exchange rate market, then that currency will be subject to:

a floating exchange rate

Short run speculation in currencies can create ____________, at least for a time, where an expected appreciation leads to a stronger currency and vice versa.

a self-fulfilling prophecy

Hard peg

an exchange rate policy in which the central bank sets a fixed and only rarely changing value for the exchange rate

What is the main characteristic relating to "hard peg"?

an exchange rate policy in which the central bank sets a fixed and unchanging value for the exchange rate

Soft peg

an exchange rate policy where the government usually allows the exchange rate to be set by the market, but in some cases, especially if the exchange rate seems to be moving rapidly in one direction, the central bank will intervene

Portfolio investment

an investment in another country that is purely financial and doesn't involve any management responsibility

If the U.S. government uses an expansionary monetary policy to reduce interest rates, then it will:

cause the exchange rate for U.S. currency to depreciate

What does it mean to hedge a financial transaction?

creating a contract and paying a fee to ensure that a future payment in foreign currency is not affected by potential falling exchange rates

Portfolio investments are often made based on beliefs about how ____________ are likely to move in the near future.

exchange rates

From a macroeconomic point of view, increases in ____________ are an addition to aggregate demand, while increases in ____________ are a subtraction from aggregate demand.

exports; imports

What term is used to describe when a country lets the value of its currency to be determined in the exchange rate market?

floating exchange rate

What's is the difference between foreign direct investment and portfolio investment?

foreign direct investments are purchases of firms in another country that involve taking a management responsibility, such as the purchasing of another firm; portfolio investments are purely financial investments such as purchasing foreign issued bonds or depositing money in a foreign bank account

People or firms use one currency to purchase another currency in the ____________.

foreign exchange market

Does a higher rate of return in a nation's economy, other things being equal, affect the exchange rate of its currency? If so, how?

funds from abroad will come in because financial investments will be more beneficial to investors; demand for the nation's currency will shift to the right, and supply will shift to the left, strengthening the currency

If a government uses monetary policy to alter the exchange rate, then it cannot at the same time use monetary policy to address issues of ____________.

inflation or recession

If the Canadian dollar is strengthening, then:

is has appreciated in terms of other currencies

How can an unexpected fall in exchange rates injure the financial health of a nation's banks?

it can make it more difficult for one country to repay their creditors, since their currency will buy a smaller amount of foreign currency

Foreign direct investment

purchases of firms in another country that involves taking a management responsibility

____________ equalized the prices of internationally traded goods across countries.

purchasing power parity

When a government uses a ____________ exchange rate policy, it usually, but not always, allows the exchange rate to be set by the market.

soft peg

Foreign direct investment is the term used to describe purchases of firms in another country that involve ____________

taking a management responsibility

If a nation merges its currency with another nation to create a single currency, what must it give up?

the ability to determine its own nationally-oriented monetary policy

Does a higher inflation rate in an economy, other things being equal, affect the exchange rate of its currency? If so, how?

the currency's buying power decreases, and so international investors will be less eager to hold it; demand would decrease to the left, and supply would increase to the right, weakening the currency

Does an expectation of a stronger exchange rate in the future affect the exchange rate in the present? If so, how?

the demand for the currency will increase due to a desire to benefit from appreciation, causing the currency to appreciate automatically and encourage other investors to believe in future appreciation and lead to even further appreciation

Purchasing power parity (PPP)

the exchange rate that equalizes the prices of internationally traded goods across countries

What is the purchasing power parity rate?

the exchange rate that equalizes the prices of internationally traded goods across countries; used in international comparison of GDP

What is the foreign exchange market?

the market in which people and firms exchange one currency to purchase another currency

Foreign exchange market

the market in which people buy one currency while using another currency

A soft peg policy typically allows the exchange rate to move up and down by relatively small amounts in ____________, but seeks to avoid extreme short-term fluctuations.

the short run

A ____________ monetary policy can be used to decrease aggregate demand because it ____________ exports and ____________ imports.

tight; stimulates; reduces

Hedge

using a financial transaction as protection against risk

What is meant by "hedge"?

using a financial transaction as protection against risk

A depreciating U.S. dollar is ____________ because it is worth ____________ in terms of other currencies

weakening; less

Floating exchange rate

when a country lets the value of its currency be determined in the exchange rate market

Dollarize

when a country that is not the United States uses the U.S. dollar as its currency

What does it mean to say that a currency appreciates?

when a currency becomes stronger; when it becomes worth more than another currency

What does it mean to say that a currency depreciates?

when a currency becomes weaker; when it becomes worth less than another currency

Depreciating

when a currency is worth less in terms of other currencies; also called "weakening"

Appreciating

when a currency is worth more in terms of other currencies; also called "strengthening"