demand for imports, the interest rate in the United States and other countries, and the expected future exchange rate.. demand for imports, the interest rate in the United States and oth
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A n s w e r s t o t h e R e v i e w Q u i z z e s
Page 256 (page 664 in Economics)
1 What are the influences on the demand for U.S dollars in the foreign
exchange market?
The demand for U.S dollars depends on four main factors: the exchange rate, the world demand for U.S exports, the interest rate in the United State and other countries, and the expected future exchange rate
2 What are the influences on the supply of U.S dollars in the foreign exchange market?
The supply of U.S dollars depends on four main factors: the exchange rate, the U.S demand for imports, the interest rate in the United States and other countries, and the expected future exchange rate
3 How is the equilibrium exchange rate determined?
The equilibrium exchange rate is the exchange rate that sets the quantity of U.S dollars demanded equal to the quantity of U.S dollars supplied At the equilibrium exchange rate there is neither a shortage nor a surplus of U.S dollars
4 What happens if there is a shortage or a surplus of U.S dollars in the foreign exchange market?
If there is a shortage of U.S dollars, the quantity of U.S dollars demanded exceeds the quantity supplied As long as there is a shortage, this upward pressure on the price automatically forces the price higher to its equilibrium
If there is a surplus of U.S dollars, the quantity of U.S dollars demanded is less than the quantity supplied As long as there is a surplus, this downward pressure
on the price automatically forces the price lower to its equilibrium
5 What makes the demand for U.S dollars change?
Three factors change the demand for U.S dollars: the world demand for U.S exports, the interest rate in the United States and other countries, and the
expected future exchange rate If world demand for U.S exports increases, the demand for U.S dollars increases If the interest rate in the United States rises relative to interest rates in other countries, the demand for U.S dollars increases
RATE AND THE BALANCE OF
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And if the expected future exchange rate rises, the demand for U.S dollars
increases
6 What makes the supply of U.S dollars change?
Three factors change the supply of U.S dollars: U.S demand for imports, the interest rate in the United States and other countries, and the expected future exchange rate If U.S demand for imports increases, the supply of U.S dollars increases If the interest rate in the United States falls relative to interest rates in other countries, the supply of U.S dollars increases And if the expected future exchange rate falls, the supply of U.S dollars increases
7 What makes the U.S dollar exchange rate fluctuate?
Changes in the demand for U.S dollars and the supply of U.S dollars lead to fluctuations in the U.S dollar exchange rate Because the demand for dollars and the supply of dollars generally change at the same time and in opposite directions, exchange rate fluctuations are frequently large
Page 260 (page 668 in Economics)
1 What is arbitrage and what are its effects in the foreign exchange market?
Arbitrage is seeking to profit by buying in one market and selling for a higher price
in another market Arbitrage has several effects:
Law of one price: At any one time, an exchange rate is the same in all markets
No round-trip profit: It is impossible to make a profit by using currency A to buy currency B and then selling currency B to buy currency A It is
impossible to make a profit if even longer chains of currency are used
Interest rate parity: For risk-free transactions, the rate of return earned by a unit of currency is the same in different nations
Purchasing power parity: Purchasing power parity occurs when a unit of money buys the same amount of goods and services in different nations
2 What is interest rate parity and what happens when this condition doesn’t hold?
Interest rate parity occurs when, for risk-free transactions, the rate of return
earned by a unit of currency is the same in different nations If the rate of return for the U.S dollar is higher than that for, say, the Japanese yen, interest rate parity does not hold In this case people will expect the value of the dollar to fall against the yen (that is, the U.S dollar is expected to depreciate over time) so that interest rate parity is restored because the rate of return earned by a unit of currency is the same in both nations
3 What makes an exchange rate hard to predict?
The exchange rate depends on the expected future exchange rate The expected future is volatile For example, the U.S expected future exchange rate changes when news occurs that changes the future demand and/or supply of U.S dollars
Consequently the current demand and supply of U.S dollars changes, thereby
changing the U.S exchange rate
4 What is purchasing power parity and what happens when this condition
doesn’t hold?
Purchasing power parity means equal value of money If prices of goods and services are higher in the United States than the (exchange rate adjusted) prices of goods and services in, say, Japan, purchasing power parity does not occur because
a unit of currency buys less in the United States than in Japan The demand for
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U.S dollars decreases and the supply of U.S dollars increases so that the value of the dollar falls against the yen to restore purchasing power parity
5 What determines the real exchange rate and the nominal exchange rate in the short run?
The real exchange between the United States and Japan, RER, equals E P/P* where P is the U.S price level, P* is the Japanese price level, and E is the nominal
exchange rate in yen per dollar In the short run, changes in the nominal exchange rate bring an equal change in the real exchange rate because the price levels in Japan and the United States do not adjust instantly to a change in the nominal exchange rate
In the short run, the nominal U.S exchange rate is determined in the foreign exchange market as the exchange rate that sets the quantity of U.S dollars
demanded equal to the quantity of U.S dollars supplied
6 What determines the real exchange rate and the nominal exchange rate in the long run?
In the long run, the real exchange rate is determined by demand and supply in the goods market Identical goods in the United States and Japan sell for the same price once adjusted for the (nominal) exchange rate The relative prices of goods that are not identical are determined by the supply and demand for them and so the relative price levels in different countries are determined by supply and
demand These relative price levels determine the real exchange rate
In the long run, changes in the real exchange rate and changes in the price levels change the nominal exchange rate In the long run, the price level is determined
by the quantity of money So changes in the U.S or the Japanese quantity of
money change the price level and also bring an offsetting change in the nominal exchange rate
Page 263 (page 671 in Economics)
1 What is a flexible exchange rate and how does it work?
A flexible exchange rate policy is an exchange rate that is determined by demand and supply with no direct intervention in the foreign exchange market by the central bank In this arrangement, the forces of supply and demand with no direct central bank intervention are the only factors that influence the exchange rate
2 What is a fixed exchange rate and how is its value fixed?
A fixed exchange rate policy is an exchange rate that is pegged at a value decided
by the government or central bank The central bank directly intervenes in the foreign exchange market to block the unregulated forces of supply and demand from changing the exchange rate away from its pegged value For instance, if a central bank wanted to hold the exchange rate steady in the presence of
diminished demand for its currency, the central bank props up demand by buying its currency in the foreign exchange market to keep the exchange rate from falling
If the demand for its currency increases, the central bank increases the supply by selling its currency and keeps the exchange rate from rising
3 What is a crawling peg and how does it work?
A crawling peg exchange rate policy selects a target path for the exchange rate and then uses direct central bank intervention in the foreign exchange market to achieve that path A crawling peg works like a fixed exchange rate except that the central bank changes the target value of the exchange rate in accord with its target path
4 How has China operated in the foreign exchange market, why, and with what effect?
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From 1997 until 2005, the People’s Bank of China fixed the Chinese yuan exchange rate Over this time, the demand for the yuan increased, so the People’s Bank of China supplied additional yuan to keep the exchange rate constant By supplying yuan, the People’s Bank acquired large amounts of foreign currency In addition, by fixing its exchange rate China essentially pegged its inflation rate to equal the U.S inflation rate Since 2005 the yuan has been allowed to appreciate slightly as the People’s Bank moved to a crawling peg exchange rate policy The exchange rate has not been allowed to change much, so over the long run the Chinese inflation rate remains closely tied to U.S inflation
Page 269 (page 677 in Economics)
1 What are the transactions that the balance of payments accounts record?
The current account records payments for imports of goods and services from
abroad, receipts from exports of goods and services sold abroad, net interest income paid abroad, and net transfers abroad (such as foreign aid payments) The
capital and financial account records foreign investment in the U.S minus U.S
investment abroad Any statistical discrepancy is also recorded in the capital account The official settlements account records the change in U.S official
reserves
2 Is the United States a net borrower or a net lender? Is it a debtor or a creditor nation?
The United States is a net borrower and is a debtor nation
3 How are net exports and the government sector balance linked?
Net exports is the value of exports of goods and services minus the value of
imports of goods and services Net exports is equal to the sum of government
sector surplus or deficit plus the private sector surplus or deficit The government
sector balance is equal to net taxes minus government expenditure on goods and services If the government sector balance is negative, then the government sector has a deficit, that is, a budget deficit Because net exports equals the sum of the government sector balance plus private sector balance, if the government budget deficit increases and the private sector balance does not change, the value of net exports becomes more negative
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A p p l i c a t i o n s
Use the following data to work Problems 1 to 3
The U.S dollar exchange rate increased from $0.96 Canadian in June 2011 to $1.03 Canadian in June 2012, and it decreased from 81 Japanese yen in June 2011 to 78 yen in June 2012
1 Did the U.S dollar appreciate or depreciate against the Canadian dollar? Did the U.S dollar appreciate or depreciate against the yen?
The U.S dollar appreciated against the Canadian dollar and it depreciated against the yen
2 What was the value of the Canadian dollar in terms of U.S dollars in June
2011 and June 2012? Did the Canadian dollar appreciate or depreciate
against the U.S dollar over the year June 2011 to June 2012?
One Canadian dollar was worth 104 U.S cents in June 2011 and 97 U.S cents in June 2012 The Canadian dollar depreciated against the U.S dollar
3 What was the value of 100 yen in terms of U.S dollars in June 2011 and June 2012? Did the yen appreciate or depreciate against the U.S dollar over the year June 2011 to June 2012?
One hundred yen was worth 123 U.S cents in June 2011 and 128 U.S cents in June
2012 The yen appreciated against the U.S dollar
4 On March 30, 2012, the U.S dollar was trading at 82 yen per U.S dollar on the foreign exchange market On August 30, 2012, the U.S dollar was trading
at 79 yen per U.S dollar
a What events in the foreign exchange market could have brought this fall in the value of the U.S dollar?
The fall in the U.S exchange rate is the result of a decrease in the demand for U.S dollars and/or an increase in the supply of U.S dollars Factors that decrease the demand for U.S dollars include a decrease in the Japanese demand for U.S
exports; a fall in the U.S interest rate relative to the Japanese interest rate; and, a fall in the expected future exchange rate Factors that increase the supply of U.S dollars include an increase in the U.S demand for Japanese imports; a fall in the U.S interest rate relative to the Japanese interest rate; and, a fall in the expected future exchange rate
b Did the events you’ve described change the demand for U.S dollars, the supply of U.S dollars, or both demand and supply in the foreign exchange market?
A decrease in the Japanese demand for U.S exports leads to only a decrease in the demand for U.S dollars An increase in the U.S demand for Japanese imports leads only to an increase in the supply of U.S dollars The other factors, a fall in the U.S interest rate relative to the Japanese interest rate and a fall in the expected
future exchange rate, change both the demand for U.S dollars and the supply of U.S
dollars
Trang 65 Colombia is the world’s biggest producer of roses The global demand for
roses increases and at the same time Colombia’s central bank increases the
interest rate In the foreign exchange market for Colombian pesos, what
happens to
a The demand for pesos?
The demand for the peso increases because the Colombian interest rate
differential increases and because the demand for Colombia’s export, roses,
increases
b The supply of pesos?
The supply of the pesos decreases because the Colombian interest rate differential increases
c The quantity of pesos demanded?
The Colombian exchange rate rises The rise in the exchange rate creates a
movement upward along the new demand curve, so along the new demand curve for pesos, the quantity of pesos demanded decreases
d The quantity of pesos supplied?
The Colombian exchange rate rises The rise in the exchange rate creates a
movement upward along the new supply curve, so along the new supply curve of
pesos, the quantity of pesos supplied increases
e The peso-U.S dollar exchange rate?
The U.S exchange rate depreciates (and the Columbian exchange rate
appreciates) because the demand for Colombian pesos increases and the supply
decreases
6 If a euro deposit in a bank in France earns interest of 4 percent a year and a
yen deposit in Japan earns 0.5 percent a year, other things remaining the
same and adjusted for risk, what is the exchange rate expectation of the
Japanese yen?
For interest rate parity to hold, the Japanese yen must be expected to appreciate
by the difference in the interest rates So the Japanese yen must be expected to
appreciate by 4.0 percent minus 0.5 percent, or 3.5 percent
7 The U.K pound is trading at 1.50 U.S dollars per U.K pound and purchasing
power parity holds The U.S interest rate is 1 percent a year and the U.K
interest rate is 3 percent a year
a Calculate the U.S interest rate differential
The U.S interest rate differential equals 1 percent minus 3 percent, or 2 percent per year
b What is the U.K pound expected to be worth in terms of U.S dollars one
year from now?
For interest rate parity to hold, the U.K pound must be expected to depreciate 2
percent per year Therefore next year the U.K pound is expected to be equal to
0.98 1.50 U.S dollars per U.K pound, which is 1.47 U.S dollars per U.K pound
c Which country more likely has the lower inflation rate? How can you tell?
Because the U.K pound is expected to depreciate, the United Kingdom likely has
the higher inflation rate, which means that the United States is expected to have
the lower inflation rate
T H E E XC H A N G E R AT E A N D T H E B A L A N C E O F PAY M E N T S 1 1 5
Trang 78 The U.S price level is 115, the Japanese price level is 92, and the real
exchange rate is 98.75 Japanese real GDP per unit of U.S real GDP What is the nominal exchange rate?
The real exchange rate equals (E × P)/P* in which E is the nominal exchange rate,
P is the U.S price level, and P* is the Japanese price level Rearranging this
formula gives E = (real exchange rate × P*)/P Using the rearranged formula, the
nominal exchange rate equals (98.75 × 92)/115 = 79.0 yen per dollar
9 With the strengthening of the yen against the U.S dollar in 2012, Japan’s central bank did not take any action A Japanese politician called on the central bank to take actions to weaken the yen, saying it will help exporters in the short run and have no long-run effects
a What is Japan’s current exchange rate policy?
Japan’s current exchange rate policy is a flexible exchange
b What does the politician want the exchange rate policy to be in the short run? Why would such a policy have no effect on the exchange rate in the long run?
The politician wants the exchange rate to be a crawling peg by lowering it over a period of time This policy has no effect on the exchange rate in the long run because in the long run the real exchange rate is determined by supply and
demand for the nation’s goods In addition, the nominal exchange rate adjusts to make the ratio of the nations’ price levels equal to the real exchange rate
1 1 6 C H A P T E R 9
Trang 810 The table gives some information
about the U.S international
transactions
a Calculate the balance on the three
balance of payments accounts
The current account balance equals
exports of goods and services
($1,754 billion) minus imports of
goods and services ($2,215 billion)
plus net interest income ($167
billion) plus net transfers ($142
billion) So the current account
balance is $436 billion
The capital and financial account
balance equals foreign investment in
the United States ($1,408 billion)
minus U.S investment abroad ($1,200 billion) plus the statistical discrepancy
($231 billion) So the capital and financial account balance is $439 billion
The official settlements account balance equals current account balance ($436
billion) capital and financial account balance ($439 billion) So the official
settlements account balance is −$3 billion Because the official settlements
account is negative, U.S official reserves are increasing
b Was the United States a net borrower or a net lender? Explain your answer
The United States was a net borrower because foreign investment in the United
States exceeded U.S investment abroad
Item
Billions of U.S
dollars Imports of goods and
services
2,215 Foreign investment in
the United States
1,408
Exports of goods and
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Trang 9Answers to Additional Problems and Applications
11 Suppose that yesterday, the U.S dollar was trading on the foreign exchange market at 0.75 euros per U.S dollar and today the U.S dollar is trading at 0.80 euros per U.S dollar Which of the two currencies (the U.S dollar or the euro) has appreciated and which has depreciated today?
The U.S dollar appreciated because its exchange rate rose The euro depreciated because its exchange rate fell (from 1.33 U.S dollars per euro to 1.25 U.S dollars per euro)
12 Suppose that the exchange rate rose from 80 yen per U.S dollar to 90 yen per U.S dollar What is the effect of this change on the quantity of U.S dollars that people plan to sell in the foreign exchange market?
The rise in the exchange rate increases the quantity of U.S dollars that people plan to sell in the foreign exchange market
13 Suppose that the exchange rate for the Mexican peso fell from 15 pesos per U.S dollar to 10 pesos per U.S dollar What is the effect of this change on the quantity of U.S dollars that people plan to buy in the foreign exchange
market?
The fall in the exchange rate increases the quantity of U.S dollars that people plan
to buy in the foreign exchange market
14 Today’s exchange rate between the Lebanese pound and the U.S dollar is 1,500 LBP per dollar and the central bank of Lebanon is buying U.S dollars in the foreign exchange market If the central bank of Lebanon did not purchase U.S dollars would there be excess demand or excess supply of U.S dollars in the foreign exchange market? Would the exchange rate remain at 1,500 LBP per U.S dollar? If not, which currency would appreciate?
In the absence of the purchases by the central bank of Lebanon, there would be an excess supply of U.S dollars in the foreign exchange market Without these
purchases, the exchange rate would fall from 1,500 LBP per dollar to something lower The Lebanese pound would appreciate (and the U.S dollar would
depreciate)
15 On October 25, 2000, the exchange rate was 0.8307 U.S dollar per euro It increased to 1.588 U.S dollars per euro on July 16, 2008, and then decreased
to 1.0557 U.S dollar per euro on March 16, 2015 If the euro is expected to bounce back to its 2008 exchange rate, explain how this would affect the demand for and the supply of euros in the foreign exchange market?
If the euro is expected to bounce back to its 2008 exchange rate, it raises the expected profit from holding euros and thereby affects both the demand for and the supply of euros The rise in the expected profit from holding euros increases the demand for euros because people would rather hold more profitable
currencies But the supply of euros will decrease
16 The exchange rate changed from 1.0557 U.S dollar per euro on July 16, 2008
to 1.588 U.S dollars per euro on March 16, 2015 Which factors caused these
changes in the exchange rate? Which factors would change both demand and
supply?
The factors that influenced the exchange rate for the euro include (i) the Eurozone debt crisis which caused the investors to invest less in Eurozone sovereign bonds The investors preferred to invest in bonds of other countries such as the U.S (ii) The European Central Bank kept interest rates low and started pumping euros into the money market to boost the economy (iii) The demand for U.S exports and
1 1 8 C H A P T E R 9
Trang 10European imports dropped because of the U.S subprime mortgage crisis that
caused a recession in the U.S and the Eurozone Because of these reasons, there is
a high supply of and a lower demand for euros, pushing the euro down Changes in the interest rate differential and expected future exchange rate between the U.S
and the Eurozone can change both demand and supply
17 Australia produces natural resources (coal, iron ore, natural gas, and others), the demand for which has increased rapidly as China and other emerging
economies expand
a Explain how growth in the demand for Australia’s natural resources would
affect the demand for Australian dollars in the foreign exchange market
The growth in demand for Australia’s natural resources increases the demand for Australian dollars
b Explain how the supply of Australian
dollars would change
Absent any change in the expected
future exchange rate, the supply of
Australian dollars does not change (there
is a change in the quantity supplied)
c Explain how the value of the Australian
dollar would change
The increase in demand for Australian
dollars raises the value of the Australian
dollar
d Illustrate your answer with a graphical
analysis
Figure 9.1 illustrates the effect of the
increase in demand for Australian
dollars The demand curve for Australian
dollars shifts rightward, from D0 to D1
The supply curve does not shift The
exchange rate rises from 90 yen per Australian dollar to 95 yen per Australian
dollar
Use the following news clip to work Problems 18 and 19
Indian Entrepreneur Seeks Opportunities
Rahul Reddy, an Indian real estate entrepreneur, believes that “The United States
is good for speculative higher-risk investments.” He profited from earlier
investment in Australia and a strong Australian dollar provided him with the funds
to enter the U.S real estate market at prices that he believed “we will probably not see for a long time.” He said, “The United States is an economic powerhouse that I think will recover, and if the exchange rate goes back to what it was a few years
ago, we will benefit.”
Based on an article in Forbes, July 10, 2008
18 Explain why Mr Reddy is investing in the U.S real estate market
At the time of the news article, the U.S dollar had depreciated The short-run effect
of this depreciation was to make U.S goods and services and U.S properties less
expensive for foreigners Mr Reddy, among others, was trying to take advantage of the lower price by purchasing investment properties and development
opportunities in the United States
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