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Chapter 30: Problem 15

Although it is a member of the European Community, Denmark is not part of the euro zone; it has its own currency, the krone. Because the krone is pegged to the euro, Denmark's central bank is obliged to maintain the value of the krone within 2.25 percent either above or below the value of the euro. According to a 2017 article in the Wall Street Journal, the Danish central bank was forced to intervene in foreign currency markets "to keep the krone from strengthening too much." a. If the krone was strengthening, did it take more kroner to exchange for a euro or fewer kroner? Briefly explain. b. Given your answer to part (a), was the Danish central bank intervening by buying kroner in exchange for euros or selling kroner in exchange for euros? Briefly explain.

Short Answer

Expert verified
In the given scenario when the krone is strengthening: a. It would take fewer kroner to exchange for a euro. b. The Danish central bank would be selling kroner in exchange for euros to reduce the value of the kroner and maintain the peg.

Step by step solution

01

Understand Currency Strength

When a currency 'strengthens', it becomes more valuable compared to another currency. As a result, it will take fewer units of that currency to exchange for one unit of the other currency.
02

Krone Strengthen Against Euro

So, if the krone was strengthening, it implies that the krone is gaining value relative to the euro. That will mean it takes fewer kroner to exchange for a euro.
03

Understand Central Bank Intervention

Central banks intervene in foreign currency markets to maintain the value of their currency. This is usually achieved by buying or selling their own currency.
04

Danish Bank Intervention

If the krone is strengthening too much, the Danish central bank would strive to reduce its value to maintain it within the pegged range. This can be achieved by increasing the supply of kroner in the market, which will decrease its value. The Danish central bank would do this by selling kroner in exchange for euros.

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Most popular questions from this chapter

(Related to the Apply the Concept on page 1067 ) The United Kingdom decided not to join other European Union countries in using the euro as its currency. One opponent of adopting the euro argued, "It comes down to economics. We just don't believe that it's possible to manage the entire economy of Europe with just one interest rate policy. How do you alleviate recession in Germany and curb inflation in Ireland?" a. What interest rate policy would be used to alleviate recession in Germany? b. What interest rate policy would be used to curb inflation in Ireland? c. What does adopting the euro have to do with interest

What does it mean when one currency is "pegged" against another currency? Why do countries peg their currencies? What problems can result from pegging?

(Related to the Chapter Opener on page 1058 ) An article in the Wall Street Journal in June 2017 began with this observation: "The euro soared to its biggest one-day gain against the dollar in a year." Bayer AG sells Coppertone sunscreen in the United States. If Bayer produces Coppertone in the United States and sells it only in the United States, would an increase in the value of the euro against the dollar affect the company's profit from selling Coppertone? Briefly explain.

In December \(2016,\) you needed 83 percent more pesos to buy one U.S. dollar than you had needed in December 2004\. Over the same time period, the consumer price index in Mexico increased 57.8 percent, and the consumer price index in the United States increased 26.7 percent. Are these data consistent with the theory of purchasing power parity? Briefly explain.

An article in the Toronto Star discussed the Canadian teams that play in the National Hockey League, the National Basketball Association, Major League Baseball, and Major League Soccer. The article noted, "Under their collective agreements players get paid in U.S. dollars. The majority of [team] revenue, however, is in Canadian currency." Are Canadian professional sports teams better off when the Canadian dollar increases in value relative to the U.S. dollar or when it decreases in value? Briefly explain.
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