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 recently undertook an unanticipated expansionary fiscal policy action.

B) government undertook an unanticipated expansionary monetary 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). The increased aggregate demand results in higher economic growth and higher inflation. These two factors normally result in currency depreciation in the long run. An unanticipated shift to a more expansionary fiscal policy will, however, in the short run (and we are told that the policy change was recent) lead to appreciation. 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 policy change is recent and there should have been recent appreciation if the government recently undertook an unanticipated expansionary fiscal policy action.

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

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

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

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

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

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

A) spending by firms.

B) income growth.

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

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.

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 depreciate relative to the foreign currency.

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

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

土豆妮

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 depreciate in value.

B) cause the dollar to appreciate 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.

土豆妮

A Japanese automobile manufacturer builds an automobile plant in the U.S. In the foreign exchange market, this action creates a:

A) supply of dollars and a demand for yen.

B) demand for dollars and a surplus of yen.

C) demand for both dollars and yen.

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The Japanese automaker will need to buy U.S. dollars to pay for costs in the United States such as payments to workers, overhead costs, supplies and materials. Thus, the Japanese automaker will be looking to trade yen for dollars, creating a demand for dollars and a surplus of yen.