ECO102H1 Lecture Notes - Lecture 23: Devaluation, Foreign Exchange Market, Capital Account

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19 Aug 2016

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ECO102H1 Full Course Notes

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If the exchange rate rises, foreign currency becomes more expensive (quantity demanded decreases: an increase in the exchange rate is a depreciation of the canadian dollar. If the exchange rate falls, foreign currency becomes less expensive (quantity demanded increases: a decrease in the exchange rate is an appreciation of the canadian dollar. Any change in demand or supply will alter the equilibrium exchange rate. An increase in the supply of us dollars will cause the value of the exchange rate to fall (the. An increase in the demand for us dollars will cause the value of the exchange rate to rise (the. Shifts of the supply/demand of foreign currency are caused by: inflation. If there is equal inflation in the us, no changes to equilibrium exchange rate. If pcanada > pus, exports decrease and imports increase: when exports decreases, supply of usd decreases, when imports increase, demand for usd increases, canadian dollar will be depreciating.

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Assume that the U.S. dollar and the Japanese yen are the only two currencies in the world.

a. A bilateral nominal exchange rate S is the spot (now) exchange value of one currency in terms of the other and S can be written as dollars per 1 yen or yen per 1 dollar. If S = yen/1 dollar = 76.92 then the inverse 1/S gives dollars per 1 yen where 1/S = 1/(yen/1 dollar) = 1/76.92 = .013. If the 1/S increases to .014, has the dollar appreciated (1 dollar is worth more yen) or depreciated (1 dollar is worth less yen)? Explain.

b. Changes in demand and supply in the foreign exchange (FX) market determine the value of floating exchange rates S. If S is expressed as S = yen/1 dollar, then we have the FX market in terms of the demand and supply of dollars. (If S = dollars/1 yen, then we get the FX market in terms of the demand and supply of yen. Note also that no matter which currency the FX market is expressed, it is still an FX market where dollars are exchanged for yen. This means that an upward-sloping supply of dollars curve is exactly the same as a demand for yen curve and a downward-sloping demand for dollars curve is exactly the same as a supply of yen curve). Using S = yen/1 dollar and the FX market in terms of the demand and supply of dollars, an increase in S (dollar appreciation) leads to an increase in the number of dollars supplied (increase in the quantity of yen demanded). For dollar demand (or the supply of yen), an increase in S (dollar appreciation) leads to a decrease in the number of dollars demanded (or an increase in the number of yen supplied). The dollar demand curve shifts to the right if more yen are offered for dollars at any exchange rate S. An increase in dollar demand is caused mostly by private sector transactions in the current and capital accounts. Either an increase in demand for U.S. goods (merchandise trade in the current account) or an increase in demand for U.S. stocks and bonds (capital account inflows) will shift the dollar demand curve to the right. If private transactions in the current and capital accounts also cause shifts in the dollar supply curve, what are the corresponding factors that would lead to an increase in dollars supplied (yen demanded) at any exchange rate S?

brownhorse801

If a government fixes the exchange rate so as to generate a surplus of the domestic currency, the exchange rate (U.S. dollars per unit of the other currency) will tend to _____. To maintain the fixed exchange rate, the government must _____ the domestic currency.

1.	rise; increase the international demand for
2.	fall; increase the domestic supply of
3.	fall; decrease the international demand for
4.	fall; increase the international demand for

azuregnu566

Which of the following statements is accurate in regards to the US dollar:

A.	The central bank is responsible for printing the domestic currency and the value of the currency is adjusted to maintain a fixed level to another currency.
B.	The central bank has no ability to print the domestic currency and dollarization was adopted to minimize domestic inflation.
C.	Banks are responsible for printing the domestic currency and there is a floating exchange rate.
D.	The central bank (e.g. Federal Reserve) is responsible for printing the domestic currency and there is a floating exchange rate.

Suppose that monetary policy in the United States leads to an increase in interest rates relative to those in Japan. Which of the following will occur in the capital account:

A.	The demand for yen will increase.
B.	The dollar will appreciate relative to the yen.
C.	The supply of dollars will increase.
D.	The dollar will depreciate relative to the yen.

An expansionary monetary policy by the Fed would tend to:

A.	Lower the U.S. inflation rate, make exports cheaper, make imports more expensive, and raise the value of the dollar.
B.	Raise the U.S. inflation rate, make exports more expensive, make imports cheaper, and lower the value of the dollar.
C.	Raise the U.S. inflation rate, make exports cheaper, make imports more expensive, and raise the value of the dollar.
D.	Lower the U.S. inflation rate, make exports more expensive, make imports cheaper, and lower the value of the dollar.

cerisecod404

ECO102H1 Lecture Notes - Lecture 23: Devaluation, Foreign Exchange Market, Capital Account

ECO102H1 Full Course Notes

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