RobertA

Larry Goren, CFA, is an economist for the Federal Reserve Bank. He is interested in using a country’s balance of payments as a forecasting tool in determining exchange rates. He notices that China has a high current account balance resulting in a large surplus in its balance payments. It can be implied that:

A) China provided a great deal of financial assistance to other nations.

B) China’s international currency reserve holdings have increased.

C) China received a great deal of income flows from the sale of trade merchandise and services and payments on its existing investments.

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A large increase in China’s current account can only mean that it has received income from the sale of its trade merchandise (exports) and payments on its existing investments. Both remaining transactions affect the other elements of the balance of payment accounts. If China lends financial assistance to other nations, it shows up in its capital account and if its foreign currency reserves increase, it shows up in its official reserve account.

RobertA

Under a system of flexible exchange rates, which one of the following is more likely to cause a nation's currency to appreciate on the foreign exchange market?

A) A domestic inflation rate lower than the nation's trading partners.

B) A decrease in real domestic interest rates.

C) A domestic inflation rate higher than the nation's trading partners.

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If a nation's trading partners prices are increasing twice as fast as the domestic country A, then foreign citizens will increase their demand for A's goods. This increased demand will appreciate country A's currency making country A's goods more expensive offsetting the effects of inflation.

RobertA

The U.S. imposes a high tariff on a major imported item. Under a system of flexible exchange rates, this would tend to:

A) cause the dollar to appreciate in value.

B) cause the dollar to depreciate in value.

C) increase the balance of trade deficit of the U.S.

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The demand for imports would decrease due to their higher price because of the tariff. This would cause U.S. exports to increase relative to imports. When a country has increased exports relative to its imports, its currency will appreciate.

bigredhockey55

Which of the following factors is least likely to affect foreign exchange rates?

A) The government sets a price floor for the price of wheat.

B) Income growth.

C) Real interest rates.

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The three major factors that cause a country's currency to appreciate or depreciate relative to another's are:

• Differences in income growth among nations will cause nations with the highest income growth to demand more imported goods. Heightened demand for imports will increase demand for foreign currencies, and foreign currencies will appreciate relative to the domestic currency.
• Differences in inflation rateswill cause the residents of the country with the highest inflation rate to demand more imported (cheaper) goods. If a country’s inflation rate is higher than its trading partner’s, the demand for the country’s currency will be low, and the currency will depreciate.
• Differences in real interest rates will cause a flow of capital into those countries with the highest available real rates of interest. Therefore, there will be an increased demand for those currencies, and they will appreciate relative to countries whose available real rate of return is low.

bigredhockey55

If incomes in the U.S. are increasing rapidly compared to those in Mexico, how will the value of the U.S. dollar and the Mexican peso move relative to each other?

U.S. Dollar

Peso

A) Depreciate Appreciate

B) Appreciate Depreciate

C) Depreciate No change

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Rapid growth of U.S. incomes relative to incomes in Mexico will stimulate imports from Mexico, causing an increased demand for the peso. The increased demand for pesos will cause the peso to appreciate relative to the dollar.

bigredhockey55

How would an unanticipated shift to a more expansionary monetary policy in the United States typically affect the demand for foreign currencies and the value of the dollar?

Demand for Foreign Currencies

Foreign Exchange Value of the Dollar

A) Increase Decrease

B) Increase No change

C) No change Decrease

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An unanticipated shift to an expansionary monetary policy will lead to higher income, an accelerated inflation rate, and lower real interest rates. The higher income and higher domestic prices stimulate imports and discourage exports causing the current account balance to move toward deficit.

bigredhockey55

If the domestic inflation rate is lower than the foreign rate of inflation:

A) the domestic currency will appreciate relative to the foreign currency.

B) the domestic currency will depreciate relative to the foreign currency.

C) the foreign currency will appreciate relative to the domestic currency.

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If a nation's trading partners prices are increasing twice as fast as the domestic country A, then foreign citizens will increase their demand for A's goods. This increased demand will cause country A's currency to appreciate making country A's goods more expensive offsetting the effects of inflation differences.

bigredhockey55

Which of the following would be most likely to cause a nation’s currency to depreciate?

A) Slow growth of income relative to one’s trading partners.

B) A rate of inflation that is lower than that of one’s trading partners.

C) Domestic real interest rates that are lower than those of other countries.

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Three major factors cause a country’s currency to appreciate or depreciate:

• The growth rate of income relative to trading partners (high growth → depreciation).
• The rate of inflation relative to trading partners (high inflation → depreciation).
• Domestic real interest rates relative to those of other countries (low real rates → depreciation).

bigredhockey55

Mexico eliminates a high tariff on a major imported item. Under a system of flexible exchange rates, this action would tend to:

A) decrease the balance of trade deficit of Mexico.

B) cause the peso to depreciate in value.

C) cause the peso to appreciate in value.

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By eliminating a high tariff on a major imported item under flexible exchange rates, demand for foreign goods increases, causing the peso to depreciate.

bigredhockey55

Which of the following is least likely to affect exchange rates? Differential:

A) income growth.

B) inflation rates.

C) spending by firms.

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The main determinant of exchange rates is the supply and demand for a currency, which is determined by the difference between the two countries