HW #10

Given exchange rate A/B and C/B, how do you find A/C?

(A/B)/(C/B)

Peru says, "We are one of the most open economies of Latin​ America." Is fiscal policy in Peru likely to be more or less effective than it would be in a less open​ economy? Briefly explain.

*Fiscal policy will have a smaller impact on aggregate demand in an open economy than in a less open economy.* In an open​ economy, an expansionary fiscal policy usually results in higher interest​ rates, that reduces domestic​ investment, consumption of durables and increases the foreign exchange value of the dollar leading to a decrease in net exports. Thus the *crowding out effect* is larger in an open economy. On the other​ hand, only consumption and investment are crowded out by an expansionary fiscal policy in a closed economy. In an open​ economy, net exports are also crowded out. A contractionary fiscal policy *will not be effective* in an open economy as it will have a smaller impact on aggregate demand and therefore will be less effective in slowing down an​ economy.Therefore, in general fiscal policy is less effective in an open economy.

What is the *main* set of factors that cause the supply and demand curves in the FOREX to shift

1) desire to invest 2) demand for goods and services 3) speculation about future value Changes in the *desire to invest* in the U.S. and changes in the desire to invest in foreign countries. Changes in the demand for​ U.S.-produced *goods and services* and changes in the demand for​ foreign-produced goods and services. *speculation* by currency traders about the likely future value of the dollar and the likely future value of foreign currencies.

What happens graphically when the dollar appreciates against another currency

1) exchange rate goes up 2) *demand curve shifts up and to the right* (more traded at a higher exchange rate)

What could cause a shift in demand up and to the right on the exchange rate graph?

2. Income rises in Japan. (money supply in other country increases) 3. Speculators begin to believe the value of the dollar will be higher in the future.

A country that runs a current account surplus must run a financial account (surplus, deficit)

A country that runs a current account surplus must run a financial account *deficit*

A strengthening of the dollar would reduce the inflation rate in the United States because

A strengthening of the dollar would reduce the inflation rate in the United States because net exports and aggregate demand would​ fall, lowering the price level.

What increases a foreign currency demand?

Foreign firms and consumers who want to invest Foreign firms and consumers who want to buy goods and services Currency traders who believe that the value of the currency in the future will be greater than its value today

Which of the following best explains why higher inflation will cause the Australian dollar to depreciate relative to the New Zealand​ dollar?

If prices of goods and services rise faster in Australia than in New​ Zealand, the value of the Australian dollar has to decline to maintain the demand for Australian products.

Expansionary monetary policy is more effective in an open economy because

Interest rate decreases--> reduce the value of the​ dollar (due to increased money supply) --> increases net exports (U.S. goods cheaper)-->further increases aggregate demand.

why is the collapsing of a peg catastrophic for borrowers who used foreign currency to take out dollar loans?

Repaying the loans would now cost significantly more since the value of the currency had fallen.

According to the theory of purchasing power parity​, if the inflation rate in Australia is higher than the inflation rate in New​ Zealand, what should happen to the exchange rate between the Australian dollar and the New Zealand​ dollar?

The Australian dollar will depreciate relative to the New Zealand dollar.

The balance of payments is always (positive, negative, zero, either)

The balance of payments is always *equal to zero* Consider the fact that in​ 2008, the current account balance was minus−​$706 billion. That means that the U.S. spent​ $706 billion on​ goods, services, and other items more than it received. We also know that every dollar of that​ $706 billion was used to invest in the U.S. or was added to foreign holdings of dollars. This is logical because if the dollars were spent on U.S. goods and services or U.S.​ investments, they would have shown up in the current account.

The boost in Chinese exports and growth would come at the rest of the​ world's expense because

The boost in Chinese exports and growth would come at the rest of the​ world's expense because​ China's trading partners will have fewer exports and more​ imports, lowering their net exports and aggregate demand. AD for other countries' currency must go down when AD for China's currency goes up, because all the value in the FOREX are relative

Balance of payments

The record of a​ country's trade with other countries in​ goods, services, and assets.

Purchasing power parity

The theory that in the long​ run, exchange rates move to equalize the purchasing powers of different currencies.

The value of a currency appreciates when (greater, fewer) units of that currency are needed to purchase one unit of another currency. The value of a currency depreciates when (greater, fewer) units of that currency are needed to purchase one unit of another currency.

The value of a currency appreciates when *fewer* units of that currency are needed to purchase one unit of another currency. The value of a currency depreciates when *greater* units of that currency are needed to purchase one unit of another currency.

In the United​ States, a high government budget deficit may lead to

a high exchange value of dollar. a high interest rate. a high current account deficit.

Adopting the euro is important to interest rate policy because

countries that use the euro as their currency will not be able to set their own independent monetary policies.

A devaluation would boost Chinese exports and growth because it would take

fewer units of foreign currency to buy one​ yuan, making Chinese products less​ expensive, encouraging exports and increasing aggregate demand (Ad shift right).

Why might the​ "continued willingness of foreign investors to buy U.S. stocks and bonds and foreign companies to build factories in the United​ States" result in the United States running a current account​ deficit?

heightened demand for U.S. assets --> increases the value of the​ dollar--> increases imports and reduces exports.

The European Central Bank contributed to the fall of the euro because easier monetary policies

increase the supply of euros and lower its value.

The ​"euro's fall" benefits German exports because it takes

less foreign currency to buy one​ euro, so the relative price of German goods​ decreases, increasing German exports.

to alleviate recession, it would be desirable to (lower/raise) interest rates

lower Recession requires an expansionary monetary​ policy, while inflation implies a contractionary monetary policy.

"Strengthening of the​ dollar" means that one dollar will buy

more foreign​ currency, or the dollar has appreciated.

to curb inflation in​ Ireland, it would be desirable to (lower/raise) interest rates

raise inflation implies a contractionary monetary policy.

To maintain the pegged exchange rate of a currency that is undervalued, the central bank will need to ____________ currency of an amount _____.

sell currency of amount *demand - supply*

what does it mean when a peg "collapse"s

the central bank no longer has the dollar reserves to buy the currency

"competitive devaluation" means that the deliberate decrease in the value of the yuan was meant to

the deliberate decrease in the value of the yuan was meant to increase​ China's exports by discouraging exports from other countries.

If investors come to believe that the Fed might not be increasing interest​ rates, the value of the dollar would decline because

the lower expected return on U.S.​ dollar-denominated assets would decrease the demand for dollars.

Graphically, what happens when the rate is pegged below the equilibrium point

there is a *shortage* of currency and the currency is *undervalued*

wealth is measured by

wealth is measured by a) productive capacity and b) purchasing​ power, not by the exchange rate

Given that payment is in US dollars but revenue is in Canadian, it is less expensive to pay when the Canadian dollar relative to the US dollar

when the value of the Canadian dollar relative to the U.S. dollar​ increases, because one Canadian dollar will buy more U.S.​ dollars, so paying the players will be less expensive.