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CHAPTER 16
EXCHANGE RATES
AND MACROECONOMIC POLICY
ANSWERS TO EVEN-NUMBERED ONLINE REVIEW QUESTIONS
2. Foreigners supply foreign currency (say, in the market where their currency is
exchanged for U.S. dollars) because they want to buy U.S. goods and services or
U.S. assets. In general economists believe that the supply curve for foreign
currency is upward sloping. As the price of foreign currency increases, U.S. goods
and services become cheaper. Foreigners buy more U.S. goods and services, and
supply more foreign currency to get the dollars with which to buy the goods. The
following shift the supply of foreign currency schedule to the right: an increase in
foreign GDP, an increase in the relative interest rate in the United States, a change
in tastes that makes U.S. goods more desirable to foreigners, a relative decrease in
prices in the United States, and an expectation that the foreign currency will
depreciate. The following shift the supply of foreign currency curve to the left: a
decrease in foreign GDP, a decrease in the relative interest rate in the United
States, a change in tastes that makes U.S. goods less desirable to foreigners, a
relative increase in prices in the United States, and an expectation that the foreign
currency will appreciate.
4. In the very short run, exchange rates move mainly due to changes in interest rates
and expectations of future exchanges rates since these forces drive hot money. In
the short run, business cycles account for most of the change in exchange rates.
Countries with higher relative GDPs demand more foreign currency, causing their
own currencies to depreciate.
6. Purchasing power parity says that the exchange rate between two countries
should adjust until the average price of goods is approximately the same in the
two countries. Exchange rates might deviate from purchasing power parity
because of high transportation costs, barriers to trade, and the inherent difficulty
in trading some goods.
8. A managed float is when the central bank intervenes in the foreign currency
market to prevent an appreciation or depreciation of its currency. Governments
use a managed float to help their export-oriented industries, to keep costs down
for firms that import inputs, or to decrease the risks of international trade that
arise from exchange rate changes.
10. During the 1980s interest rates rose due to the rising budget deficit, a burst of
investment spending, and a drop in the private saving rate. All of these
contributed to a higher U.S. interest rate, and a capital inflow, as foreigners
purchased more U.S. assets than Americans purchased of foreign assets. The
dollar appreciated making American goods more expensive to foreigners, and
foreign goods cheaper to Americans, and a trade deficit resulted. The trade deficit
persisted in the 1990s because of the continuing budget deficit, strong investment
spending, and relatively low private savings.
2 Even-Numbered Answers for Economics: Principles and Applications, 4e
EVEN-NUMBERED PROBLEM SET
2. a. Setting the quantity of pounds demanded equal to the quantity supplied, we
have
10 – 2e = 4 + 3e  6 = 5e  e = 6/5, or 1.2 dollars per pound.
b. After the U.S. government intervenes, the demand for pounds equation
becomes
12 – 2e. Resolving for equilibrium, the exchange rate climbs to 1.6 dollars per
pound, a depreciation of the dollar. The U.S. government might intervene in
this way if it wanted to help its export-oriented industries.
4.
Dollars
per
Peso
S1
pesos
pesos
S2
e1
D1
e2
D2
pesos
pesos
Quantity
of pesos
a. As the U.S. interest rate rises, causing a and I to fall, U.S. GDP decreases. The
interest rate increase also makes U.S. assets are more attractive to Americans
and to Mexicans. This, combined with the fall in U.S. GDP, causes the
demand curve for Mexican pesos to shift leftward and the supply curve for
pesos to shift rightward. The U.S. dollar appreciates.
b. The U.S. dollar appreciation causes net exports to fall, further shrinking
equilibrium GDP in the U.S.
c. If the Mexican central bank raised its interest rates just as much as the United
States, then the dollar would not appreciate as much. (It might still appreciate
somewhat, depending on the relative decline in U.S. and Mexican GDP, and
the impact of these declines on U.S. net exports). While U.S. output would
still fall, it would not fall as much as in the initial analysis.
Chapter 29
6.
3
a.
b. A fixed rate of 1.41 dinars per dollar is the equivalent of $0.71 per dinar. Since
this is higher than the market equilibrium price of $0.50 per dinar, Jordan’s
central bank must buy dinars to keep the dinar from depreciating.
c. Jordan would eventually run out of foreign reserves, and so could not buy
dinars forever.
d.
An expected fall in the dinar causes the supply curve for dinars to shift rightward
from S1 to S2and the demand curve to shift leftward D1 to D2.
e. The end result is that Jordan’s central bank must buy even more dinars to
maintain the fixed rate
4 Even-Numbered Answers for Economics: Principles and Applications, 4e
8.
Since Country B has the higher inflation rate, its relative price level is rising. As
its basket of goods becomes relatively more expensive, only a depreciation of its
currency can restore purchasing power parity. Traders would buy Country A’s
currency in order to buy its goods for resale in Country B. Country A’s currency
will appreciate relative to Country B’s (alternately stated: Country B’s currency
will depreciate relative to Country A’s).
10.
Since the trade deficit at point B equals 2,000 billion yen, and since the exchange
rate is $0.01 per yen, the trade deficit measured in dollars is 2,000 billion x $0.01
= $20 billion.
MORE CHALLENGING QUESTIONS
12. More spending by the U.S. government causes U.S. interest rates to rise. This
makes U.S. assets more attractive, increasing the supply and decreasing the
demand for foreign currency. The dollar appreciates, causing net exports to fall,
thus reducing real GDP. This makes fiscal policy less effective in changing
equilibrium GDP than it would be if the effects on exchange rates were excluded.