土豆妮

Assume that one year ago, the Canadian Dollar (CAD) was quoted at Australian Dollar (AUD) 0.82500 and that today the CAD is trading at AUD 0.8011. Assume that Canada and Australia are trading partners. Which of the following statements is least likely? Over the past year, the Canadian:

A) government undertook an unanticipated expansionary monetary policy action.

B) government recently undertook an unanticipated expansionary fiscal policy action.

C) economy grew at a faster rate than the Australian economy.

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From the given exchange rates, we determine that the Canadian Dollar has depreciated against the Australian Dollar (the CAD now buys less units of AUD). An unanticipated shift to a more expansionary fiscal policy will, in the short run, (and we are told that the policy change was recent) lead to appreciation. The increased aggregate demand results in higher economic growth and higher inflation. These two factors normally result in currency depreciation. However, the third impact of the policy, increased budget deficits and government borrowing, increases real interest rates, resulting in currency appreciation. This last effect dominates in the short run.

The other statements would most likely lead to currency depreciation (or demand for foreign currency). An unanticipated shift to expansionary monetary policy would lead to currency depreciation. The expansionary policy leads to higher economic growth, an accelerated inflation rate (increased demand for foreign goods), and lower real interest rates (the country’s assets are less attractive to foreigners). All these factors cause a nation’s currency to depreciate.

土豆妮

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

A) An increase in the nation’s domestic rate of inflation.

B) An increase in real foreign interest rates.

C) A decrease in the nation’s domestic rate of inflation.

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A decrease in the nation’s domestic rate of inflation means that the nation’s currency will tend to appreciate (or depreciate less rapidly) in value. Those outside the U.S. will trade their currency for dollars in order to take advantage of the relatively lower goods prices. This will cause an increase in the demand for dollars.

土豆妮

When a country’s monetary authority increases the money supply, a unit of money:

A) loses value both in terms of the domestic goods it can buy and in terms of the foreign currency it can buy.

B) gains value both in terms of the domestic goods it can buy and in terms of the foreign currency it can buy.

C) gains value in terms of the domestic goods it can buy but loses value in terms of the foreign currency it can buy.

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An expansionary monetary policy causes inflation, which reduces domestic purchasing power. In addition, inflation causes a currency to depreciate in value.

土豆妮

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

A) income growth.

B) spending by firms.

C) inflation rates.

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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 in their: income growth, inflation rates, and interest rates.

土豆妮

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

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

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

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

土豆妮

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.

土豆妮

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) Appreciate          Depreciate

B) Depreciate          Appreciate

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.

土豆妮

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.

土豆妮

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.

土豆妮

An analyst has the following expectations for three economies over the coming year:

	Dacia	Epirus	Noricum
Income growth rate	3%	5%	3%
Inflation rate	2%	2%	5%
Domestic real interest rate	4%	3%	4%

Based on these forecasts, how should the analyst predict the currency of Dacia will change in value versus the currencies of Epirus and Noricum?

Dacia/Epirus

Dacia/Noricum

A) Depreciate Appreciate

B) Appreciate Depreciate

C) Appreciate Appreciate

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Lower income growth, lower inflation, and a higher domestic real interest rate are factors that should cause a currency to appreciate. Dacia is expected to have a lower income growth rate and a higher real interest rate than Epirus, so Dacia’s currency should appreciate relative to that of Epirus. Dacia is expected to have a lower inflation rate than Noricum, so Dacia’s currency should also appreciate against the currency of Noricum.