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Chapter 12: Problem 7

Explain how the following factors affect the dollar's exchange rate under a system of market-determined exchange rates: (a) a rise in the U.S. price level, with the foreign price level held constant; (b) tariffs and quotas placed on U.S. imports; (c) increased demand for U.S. exports and decreased U.S. demand for imports; (d) rising productivity in the United States relative to other countries; (e) rising real interest rates overseas, relative to U.S. rates; (f) an increase in U.S. money growth; and (g) an increase in U.S. money demand.

Short Answer

Expert verified
Higher U.S. price levels or increase in overseas real interest rates can lead to depreciation of the U.S. dollar, while tariffs on imports, increased demand for exports, decreased demand for imports, rising productivity, or increase in U.S. money demand can lead to the dollar’s appreciation. An increase in U.S. money growth could either appreciate or depreciate the dollar depending on the rate of inflation.

Step by step solution

01

Impact of Rising U.S. Price Level

If the U.S. price level increases while the foreign price level remains the same, it results in imported goods becoming relatively cheaper. This increases the demand for foreign currency, reducing the demand for the U.S. dollar, and leading to its depreciation.
02

Impact of Tariffs and Quotas on U.S. Imports

Tariffs and quotas on imports make imported goods more expensive. This discourages import, reducing the demand for foreign currency and increasing the demand for the U.S. dollar, leading to its appreciation.
03

Impact of Changes in Export and Import Demand

Increased demand for U.S. exports and decreased U.S. demand for imports leads to a higher demand for the U.S. dollar and lower supply of it in the foreign exchange market. This causes the U.S. dollar to appreciate.
04

Impact of Rising Productivity in the U.S.

Rising productivity in the U.S. leads to a decrease in the price of goods and makes U.S. goods more attractive in the international market, increasing the demand for the U.S. dollar and causing it to appreciate.
05

Impact of Rising Real Interest Rates Overseas

If real interest rates are higher overseas compared to U.S. rates, it would attract investment away from the U.S. towards other countries. This would increase the demand for foreign currency and decrease the demand for the U.S. dollar, leading to its depreciation.
06

Impact of Increase in U.S. Money Growth

An increase in U.S. money growth generally leads to inflation. If U.S. inflation exceeds that of other countries, this could lead to a depreciation in the U.S. dollar as the demand for foreign currency increases because foreign goods become relatively cheaper.
07

Impact of Increase in U.S. Money Demand

If there is an increase in U.S. money demand, the demand for the U.S. dollar increases, causing it to appreciate.

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Most popular questions from this chapter

Suppose that the dollar/franc exchange rate equals \(\$ 0.50\) per franc. According to the purchasing- power-parity theory, what will happen to the dol- lar's exchange value under each of the following circumstances? a. The U.S. price level increases by 10 percent and the price level in Switzerland stays constant. b. The U.S. price level increases by 10 percent and the price level in Switzerland increases by 20 percent. c. The U.S. price level decreases by 10 percent and the price level in Switzerland increases by 5 percent. d. The U.S. price level decreases by 10 percent and the price level in Switzerland decreases by 15 percent.

Assuming market-determined exchange rates, use supply and demand schedules for pounds to analyze the effect on the exchange rate (dollars per pound) between the U.S. dollar and the U.K. pound under each of the following circumstances: a. Voter polls suggest that the U.K.'s conservative government will be replaced by radicals who pledge to nationalize all foreign-owned assets. b. Both the U.K. and U.S. economies slide into recession, but the U.K. recession is less severe than the U.S. recession. c. The Federal Reserve adopts a tight monetary policy that dramatically increases U.S. interest rates. d. Britain's oil production in the North Sea decreases, and exports to the United States fall. e. The United States unilaterally reduces tariffs on U.K. products. f. Britain encounters severe inflation, while price stability exists in the United States. g. Fears of terrorism reduce U.S. tourism in the United Kingdom. h. The British government invites U.S. firms to invest in British oil fields. i. The rate of productivity growth in Britain decreases sharply. j. An economic boom occurs in the United Kingdom that induces the U.K. consumers to purchase more U.S.-made autos, trucks, and computers. k. Ten percent inflation occurs in both the United Kingdom and the United States.

Why are international investors especially concerned about the real interest rate as opposed to the nominal rate?

In a free market, what factors underlie currency exchange values? Which factors best apply to long and short-run exchange rates?

What is meant by exchange rate overshooting? Why does it occur?
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