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"