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Chapter 22: Problem 12

Country \(X\) wants to lower the value of its currency on the foreign exchange market. Under a flexible exchange rate system, how can it do that?

Short Answer

Expert verified
Country X can lower the value of its currency in a flexible exchange rate system by increasing the supply of its money in the foreign exchange market, which can be accomplished by selling more of its currency or by implementing an expansionary monetary policy.

Step by step solution

01

Understanding flexible exchange rate

Firstly, a flexible exchange rate is primarily determined by the foreign exchange market, relying on supply and demand. When supply overtakes demand for a currency, its value decreases. Conversely, if demand for a currency exceeds the supply, it becomes more valuable.
02

Lowering currency value

So, to lower the value of its currency, Country X needs to increase its supply in the foreign exchange market. This can be done by selling more of its currency than it buys, leading to a surplus of the currency in the foreign exchange market.
03

Impact of monetary policy

Country X may also boost the supply of its currency through monetary policy. It's central bank may pursue an expansionary policy, which entails lowering interest rates or purchasing government securities. This will increase the money supply and devalue the currency, making it more affordable.

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Most popular questions from this chapter

Country 1 produces good \(X,\) and country 2 produces good Y. People in both countries begin to demand more of good \(\mathrm{X}\) and less of good \(\mathrm{Y}\). Assume that there is no labor mobility between the two countries and that a flexible exchange rate system exists. What will happen to the unemployment rate in country \(2 ?\) Explain.

What are the strong and weak points of the flexible exchange rate system? What are the strong and weak points of the fixed exchange rate system?

Suppose the United States and Japan have a flexible exchange rate system. Explain whether each of the following events will lead to an appreciation or depreciation of the U.S. dollar and Japanese yen: a. U.S. real interest rates rise above Japanese real interest rates. b. The Japanese inflation rate rises relative to the U.S. inflation rate. c. An increase in U.S. income combines with no change in Japanese income.

Explain the details of the purchasing power parity (PPP) theory.

Under a flexible exchange rate system, if the equilibrium exchange rate is \(0.10 \mathrm{USD}=1 \mathrm{MXN}\) and the current exchange rate is \(0.12=1 \mathrm{MXN},\) will the U.S. dollar appreciate or depreciate? Explain.
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