Download chapter 29 - exchange rates

CHAPTER 29 - EXCHANGE RATES
AND MACROECONOMIC POLICY
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 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 Exchange Rates and Macroeconomic Policy
6.
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.
Chapter 29 Exchange Rates and Macroeconomic Policy
8.
10.
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).
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. a. The rise in China’s price level, assuming no change in the U.S. price level, will increase
Chinese demand for U.S. goods. The supply of Yuan will increase as Chinese increase
demand for dollars to buy U.S. goods.
b. At the same time, the relatively higher price level in China will reduce demand by U.S.
residents for Chinese goods. The demand for Yuan will decrease.
c. The combined effect of an increased supply of Yuan and a decreased demand for Yuan
will be a fall in the price of the Yuan.
d. The falling price of the Yuan will reduce the level of undervaluation of the fixed rate of
$0.15 per Yuan.