ECO 3355 Chapter 17 Problems

If there is a strike in France, making it harder to buy French goods, what will happen to the value of the Euro?

Consider France to be the domestic country. Because it is harder to get French goods, people will buy more foreign goods and the value of the euro in the future will fall. The expected depreciation of the euro lowers the expected return on euro assets at any exchange rate, so the demand curve shifts to the left and the value of the euro will fall.

The Mexican peso is trading at 10 pesos per dollar. If the expected US inflation rate is 2% while the expected Mexican inflation rate is 23% over the next year, what is the expected exchange rate in one year?

Expected rate = 10 × (1.23/1.02) = 12.059 pesos per dollar

"A country is always worse off when its currency is weak (falls in value)." Is the statement true, false or uncertain? Explain your answer.

False. Although a weak currency has the negative effect of making it more expensive to buy foreign goods or to travel abroad, it may help domestic industry. Domestic goods become cheaper relative to foreign goods, and the demand for domestically produced goods increases. The resulting higher sales of domestic products may lead to higher employment, a beneficial effect on the economy.

In 1999, the Euro was trading at $0.90 per euro. If the euro is now trading at $1.16 per euro, what is the percentage change in the Euro's value? Is this an appreciation or depreciation?

% Change = (1.16 - 0.90)/0.90 = 28.88% The dollar has depreciated by 28.88%

If the Indian government unexpectedly announces that it will be imposing higher tariffs on foreign goods one year from now, what will happen to the value of the Indian rupee today?

The Indian rupee will appreciate. The announcement of tariffs will raise the expected future exchange rate for the rupee and so increase the expected appreciation of the rupee. This means that the demand for rupee-denominated assets will increase, shifting the demand curve to the right, and the rupee exchange rate therefore rises.

If the European Central Bank decides to contract the money supply to fight inflation, what will happen to the value of the US dollar vs. the Euro?

The contraction of the European money supply will increase European interest rates and raise the future value of the euro, both of which will decrease the relative expected return on dollar assets. The demand curve will then shift to the left, and the dollar will depreciate.

From 2009 to 2011, the economies of Australia and Switzerland suffered relatively mild effects from the global financial crisis. At the same time, many countries in the euro area were hit hard by high unemployment and bordered with unsustainably high government debts. How should this have affected the euro/Swiss franc and the euro/Australian dollar exchange rates?

The currencies will appreciate against the euro because the demand for euro-denominated assets will decrease

If the Bank of England prints money to reduce unemployment, what will happen to the value of the pound in the short run and the long run?

happen to the value of the pound in the short run and the long run? The pound depreciates but overshoots, declining by more in the short run than in the long run. Consider Britain to be the domestic country. The rise in the money supply leads to a higher domestic price level in the long run, which leads to a lower expected future exchange rate. In addition, the rise in the money supply lowers the domestic interest rate on pound assets. Both of these changes lower the expected return on pound assets at any given exchange rate, shifting the demand curve to the left. The short-run outcome is a lower value of the pound. However, in the long run, the domestic interest rate returns to its previous value, and the demand curve shifts back to the right somewhat. The exchange rate rises to some extent, but still remains below its initial level.

A German sports car is selling for 70,000 euros. What is the dollar price in the United States for the German car if the exchange rate is 0.90 euros per dollar?

70,000 euros × ($1/0.90 euros) = $77,777.77.

13. If the price level recently increased by 20% in England while falling by 5% in the United States, how much must the exchange rate change if PPP holds? Assume that the current exchange rate is 0.55 pounds per dollar.

0.55*1.25 =0.6875 pounds per dollar.

In the mid-to-late 1970's, the yen appreciated relative to the dollar even though Japan's inflation rate was higher than America's. How can this be explained by an improvement in the productivity of Japanese industry relative to American industry?

Even though the Japanese price level rose relative to the American, the yen appreciated because the increase in Japanese productivity relative to American productivity made it possible for the Japanese to continue to sell their goods at a profit due to the high value of the yen.

The NZ dollar to US dollar exchange rate is 1.36 NZD/USD, and the British Pound to US dollar exchange rate is 0.62 GBP/USD. If you find that the British Pound to New Zealand dollar exchange rate is 0.49 GBP/NZD, what would you do to earn a riskless profit?

Exchange $1.00 into 1.36 New Zealand dollars. Exchange the 1.36 New Zealand dollars into 0.6664 British pounds. Exchange the 0.6664 British pounds into $1.0748.

When the U.S. dollar depreciates, what happens to export and imports in the United States?

If the dollar depreciates (the exchange rate falls), the relative price of domestic goods and services falls while the relative price of foreign goods and services increases. 1. The change in relative prices will increase U.S. exports and decrease its imports.

If the demand for a country's exports falls at the same time that tariffs on imports are raised, will the country's currency tend to appreciate or depreciate in the long run?

In the long run, the fall in the demand for a country's exports leads to a depreciation of its currency, but the higher tariffs lead to an appreciation. Therefore, the effect on the exchange rate is uncertain.

If the Japanese price level rises by 5% relative to the price level in the United States, what does the theory of purchasing power parity predict will happen to the value of the Japanese Yen in terms of US dollars?

It predicts that the value of the yen will fall 5% in terms of dollars.

If the Canadian dollar to the U.S. dollar exchange rate is 1.28 CAD/USD and the British Pound to US dollar exchange rate is 0.62 GBP/USD, what must the Canadian dollar to British Pound exchange rate be?

Spot rate = 1.28 × (1/0.62) = 2.0645 Canadian dollars/pound

The president of the United States announces that he will reduce inflation with a new anti-inflation program. If the public believes him, predict what will happen to the exchange rate for the U.S. dollar vs. other currencies.

The dollar will appreciate. Because expected U.S. inflation falls as a result of the announcement, there will be an expected appreciation of the dollar and so the expected return on dollar assets will rise. As a result, the demand curve will shift to the right and the equilibrium value of the dollar will rise.

If American auto companies make a breakthrough in automobile technology and are able to produce a car that gets 60 miles to the gallon, what will happen to the US exchange rate?

The dollar will appreciate. The increase in U.S. productivity raises the expected future exchange rate and thus raises the expected return on dollar assets at any exchange rate. The resulting rightward shift of the demand curve leads to a rise in the equilibrium exchange rate.

If nominal interest rates in the US rise but real interest rates fall, predict what will happen to the US exchange rate.

The dollar will depreciate. A rise in nominal interest rates but a decline in the real rate implies a rise in expected inflation that produces an expected depreciation of the dollar that is larger than the increase in the domestic interest rate. As a result, the expected return on dollar assets falls at any exchange rate, shifting the demand curve to the left and leading to a fall in the exchange rate.

If expected inflation drops in Europe so that interest rates fall there, predict what will happen to the exchange rate for the US dollar vs. the Euro.

The dollar will depreciate. The drop of expected inflation in Europe, which leads to a decline in the foreign interest rate (which is smaller than the drop in expected inflation), leads to a decline in the relative expected return on dollar assets, because the expected euro appreciation is greater than the decline in the foreign interest rate. The result of the decline in the relative expected return on dollar assets, a leftward shift of the demand curve, and the equilibrium U.S. exchange rate falls.

When the Federal Reserve conducts an expansionary monetary policy, what happens to the money supply? How does this affect the supply of dollar assets?

The monetary supply increases, but the supply of dollar assets does not change since dollar currency is a small part of total U.S. dollar-denominated assets

If Mexicans go on a spending spree and buy twice as much French perfume, Japanese TVs, English sweaters, Swiss watches and Italian wine, what will happen to the value of the Mexican Peso.

The peso will depreciate. Consider Mexico to be the domestic country. An increased demand for imports would lower the expected future exchange rate and result in a lower expected appreciation of the peso. The resulting lower expected return on peso assets at any given exchange rate would then shift the demand curve to the left, leading to a fall in the peso exchange rate.

When the euro appreciates, are you more likely to drink California wine or French wine?

You are more likely to drink California wine because the euro appreciation makes French wine relatively more expensive than California wine.