Transcript
500Miller•Economics Today, Nineteenth Edition
Chapter 33Exchange Rates and the Balance of Payments499
Answers to Questions for Critical Analysis
Harley-Davidson’s Sales of Motorcycles Are Reduced by the Strong Dollar
(p. 742)
Given that foreign prices of exports of firms such as 3M, General Motors, and Under Armor also increased substantially, what do you think happened to amounts of foreign currencies supplied by foreign residents?
Higher foreign prices of U.S. exports will reduce the total amount of U.S. exports by foreigners. As a result, the demand for the U.S. dollar will decrease, and so the supply of foreign currencies supplied by foreign residents will also decrease.
Can Behavioral Economics Help Nations Achieve Balanced Trade (p. 746)
Why is it that if the sum of trade surpluses across all nations in the Eurozone were to shrink, the sum of trade deficits experienced by the other nations in the Eurozone also would tend to diminish?
As one nation experiences a trade surplus with another nation, the latter is experiencing a trade deficit with the former. Hence, if the sum of trade surpluses across all nations in the Eurozone were to shrink, the sum of trade deficits experienced by the nations in the Eurozone would tend to decrease as well.
You Are There
Nigeria’s Central Bank Forces a Reduction in the Demand for Foreign Exchange (p. 749)
1. Why would a naira depreciation cause Nigerian exports top become less expensive to residents of other nations?
Other things being equal, a depreciation of the naira would result in lower values of the foreign prices of Nigerian exports sold in a foreign nation.
2. Does Nigeria’s central bank appear to wish for the nation to operate with a trade deficit or a trade surplus? Explain your reasoning?
Nigeria’s central bank appears to aim at raising the currency value of the naira, which might result in a trade surplus as an appreciation of the naira would cause Nigerian exports to increase and Nigerian imports to decrease.
Issues and Applications
A Year of an appreciation, Lower Import Prices, and Higher Quantity of Foreign Exchange Demanded (pp. 750–751)
1. Other things being equal, what do you think should have happened in 2015 to the prices of goods and services exported by U.S. firms?
As a result of the dollar appreciation in 2015, the prices of goods and services exported by U.S. firms should have increased.
2. Why do you suppose that foreign expenditures on U.S. exports declined during 2015?
As a result of the dollar appreciation, the prices of U.S. exports would have increased. Residents in foreign nations would respond to the higher price of U.S.-made goods by reducing their quantity demanded and thus their expenditures on U.S. exports.
Research Project
1. For a look at the latest percentage changes in U.S. import and export prices, see the Web Links in MyEconLab.
2. To view the latest data on U.S. imports and exports, see the Web Links in MyEconLab.
Answers to Problems
33-1. Suppose that during a recent year for the United States, merchandise imports were
$2 trillion, unilateral transfers were a net outflow of $0.2 trillion, service exports were
$0.2 trillion, service imports were $0.1 trillion, and merchandise exports were $1.4 trillion.
a. What was the merchandise trade deficit?
b. What was the balance on goods and services?
c. What was the current account balance?
a. –$0.6 trillion
b. –$0.5 trillion
c. –$0.7 trillion
33-2. Suppose that during a recent year for the United States, the current account balance was
–0.5 trillion, and the net acquisitions of financial assets by U.S. residents and government entities was +$0.1 trillion.
a. What was the balance on the financial account during the year?
b. What was the net incurrence of financial liabilities by U.S. residents and government entities during the year?
a. +0.4 trillion
b. +0.3 trillion
33-3. Over the course of a year, a nation tracked its foreign transactions and arrived at the following amounts:
Merchandise exports 500
Service exports 75
Net unilateral transfers 10
Net change in domestic liabilities abroad –235
(financial outflows)
Net change in foreign assets at home 300
(financial inflows)
Merchandise imports 600
Service imports 50
What are this nation’s balance of trade, current account balance, and financial account balance?
The trade balance is merchandise exports minus merchandise imports, which equals 500 – 600 = -100, or a deficit of 100. Adding service exports of 75 and subtracting net unilateral transfers of
10 and service imports of 50 yields -100 + 75 – 10 – 50 = ?85, or a current account balance of ?85. The financial account balance equals the difference between financial inflows and financial outflows, or 300 – 200 = +100, or a financial account surplus of 100.
33-4. Identify whether each of the following items creates a surplus item or a deficit item in the current account of the U.S. balance of payments.
a. A Central European company sells products to a U.S. hobby-store chain.
b. Japanese residents pay a U.S. travel company to arrange hotel stays, ground transportation, and tours of various U.S. cities, including New York, Chicago, and Orlando.
c. A Mexican company pays a U.S. accounting firm to audit its income statements.
d. U.S. churches and mosques send relief aid to Pakistan following a major earthquake in that nation.
e. A U.S. microprocessor manufacturer purchases raw materials from a Canadian firm.
a. deficit
b. surplus
c. surplus
d. deficit
e. deficit
33-5. Explain how the following events would affect the market for the Mexican peso, assuming a floating exchange rate.
a. Improvements in Mexican production technology yield superior guitars, and many musicians around the world buy these guitars.
b. Perceptions of political instability surrounding regular elections in Mexico make international investors nervous about future business prospects in Mexico.
a. The increase in demand for Mexican-made guitars increases the demand for Mexican pesos, and the peso appreciates.
b. International investors will remove some of their financial capital from Mexico. The increase in the supply of pesos in the foreign exchange market will cause the peso to depreciate.
33-6. Explain how the following events would affect the market for South Africa’s currency, the rand, assuming a floating exchange rate.
a. A rise in U.S. inflation causes many U.S. residents to seek to buy gold, which is a major South African export good, as a hedge against inflation.
b. Major discoveries of the highest-quality diamonds ever found occur in Russia and Central Asia, causing a significant decline in purchases of South African diamonds.
a. The demand for the rand increases, so the dollar-rand exchange rate rises. Because more dollars must be given in exchange for the rand, the dollar depreciates, and the rand appreciates.
b. The demand for the rand would decrease, so the dollar-rand exchange rate falls. Because fewer dollars must be given in exchange for the rand, the dollar appreciates, and the rand depreciates.
33-7. Suppose that the following two events take place in the market for China’s currency, the yuan: U.S. parents are more willing than before to buy action figures and other Chinese toy exports, and China’s government tightens restrictions on the amount of U.S. dollar-denominated financial assets that Chinese residents may legally purchase. What happens to the dollar price of the yuan? Does the yuan appreciate or depreciate relative to the dollar?
The demand for Chinese yuan increases, and the supply of yuan decreases. The dollar-yuan exchange rate rises, so the yuan appreciates.
33-8. On Wednesday, the exchange rate between the Japanese yen and the U.S. dollar was $0,010 per yen. On Thursday, it was $0,009. Did the dollar appreciate or depreciate against the yen? By how much, expressed as a percentage change?
Because fewer U.S. dollars are required to purchase each yen, the dollar has appreciated. The percentage appreciation was 100 times (0.125 – 0.11)/0.125 = 12 percent.
33-9. On Wednesday, the exchange rate between the euro and the U.S. dollar was $1.33 per euro, and the exchange rate between the Canadian dollar and the U.S. dollar was U.S. $0.90 per Canadian dollar. What is the exchange rate between the Canadian dollar and the euro?
The Canadian dollar–euro exchange rate is found by dividing the U.S. dollar–euro exchange rate by the U.S. dollar–Canadian dollar exchange rate, or (1.33 $US/euro)/(0.90 $US/$C) = 1.48 $C/euro, or 1.48 Canadian dollars per euro.
33-10. Suppose that signs of an improvement in the Japanese economy lead international investors to resume lending to the Japanese government and businesses. How would this event affect the market for the yen? How should the central bank, the Bank of Japan, respond to this event if it wants to keep the value of the yen unchanged?
Increased foreign lending to Japan causes an increase in the demand for the yen, and the yen appreciates. The Bank of Japan should buy foreign currencies in exchange for the yen. This will increase the supply of the yen, which pushes the equilibrium exchange rate toward its original level.
33-11. Briefly explain the differences between a flexible exchange rate system and a fixed exchange rate system.
A flexible exchange rate system allows the exchange value of a currency to be determined freely in the foreign exchange market with no intervention by the government. A fixed exchange rate pegs the value of the currency, and the authorities responsible for the value of the currency intervene in foreign exchange markets to maintain this value.
33-12. Suppose that under a gold standard, the U.S. dollar is pegged to gold at a rate of $35 per ounce and the pound sterling is pegged to gold at a rate of £17.50 per ounce. Explain how the gold standard constitutes an exchange rate arrangement between the dollar and the pound. What is the exchange rate between the U.S. dollar and the pound sterling?
When the U.S. dollar is pegged to gold at a rate of $35 and the pound at a rate of £17.50, the dollar-pound exchange rate equals $35/17.50 = 2 ($/£).
33-13. Suppose that under the Bretton Woods system, the dollar is pegged to gold at a rate of $35 per ounce and the pound sterling is pegged to the dollar at a rate of $2 = £1. If the dollar is devalued against gold and the pegged rate is changed to $40 per ounce, what does this imply for the exchange value of the pound in terms of dollars?
When the dollar is pegged to gold at a rate of $35 and the pound is pegged to the dollar at $2 = £1, an implicit value between gold and the pound is established at £17.50 = 1 ounce of gold. If the dollar falls in value relative to gold, yet the pound is still valued to the dollar at $2 = £1, the pound become undervalued relative to gold. The exchange rate between the dollar and the pound will have to be adjusted to 2.29 $/£.
33-14. Suppose that the People’s Bank of China wishes to peg the rate of exchange of its currency, the yuan, in terms of the U.S. dollar. In each of the following situations, should it add to or subtract from its dollar foreign exchange reserves? Why?
a. U.S. parents worrying about safety begin buying fewer Chinese-made toys for their children.
b. U.S. interest rates rise relative to interest rates in China, so Chinese residents seek to purchase additional U.S. financial assets.
c. Chinese furniture manufacturers produce high-quality early American furniture and successfully export large quantities of the furniture to the United States.
a. The demand for yuan will decrease, which would cause the equilibrium dollar-yuan exchange rate to begin to decline. To prevent a yuan depreciation from occurring, the Bank of China can purchase yuan with dollars, thereby raising the demand for yuan to its previous level at the original exchange rate. Hence, the Bank of China should reduce its dollar reserves.
b. To purchase more U.S. financial assets, Chinese residents must obtain more dollars, so they will increase the quantity of yuan supplied at each exchange rate. This would cause the equilibrium dollar-yuan exchange rate to begin to decline. To prevent a yuan depreciation from occurring, the Bank of China can purchase yuan with dollars, thereby causing the demand for yuan to increase sufficiently to push the equilibrium exchange rate back to its original level. Thus, the Bank of China should reduce its dollar reserves.
c. U.S. residents increase the quantity of yuan demanded at any given exchange rate in order to purchase Chinese furniture, so the demand for yuan increases. This would tend to cause the equilibrium dollar-yuan exchange rate to rise, resulting in a yuan appreciation. To keep this from happening, the Bank of China can purchase dollars with yuan, thereby increasing the supply of yuan and pushing the equilibrium exchange rate back down. Consequently, the Bank of China should increase its dollar reserves.
33-15. At the point E in Figure 33-4, how many dollars per year are traded for the equilibrium quantity of pounds?
The total expenditure of dollars for pounds in the foreign exchange market equals the dollar price per pound, $1.50 per pound, multiplied by the quantity of pounds traded per year, 30 billion pounds, or $45 billion per year.
33-16. Take a look at Figure 33-5. Suppose that in response to a significant rise in interest in Jane Austen’s works and life, millions of U.S. residents suddenly purchase British-published books by and about the famous author and travel to Britain to visit Jane Austen’s former home. What will happen to the equilibrium dollar price of the pound, and why? Does the dollar appreciate or depreciate in relation to the pound?
The millions of U.S. residents have to obtain British pounds to purchase the British-published books and pay for their tours of Austen’s former home in Britain. Thus, the quantity of pounds demanded increases at each possible exchange rate, meaning that the demand curve for pounds shifts rightward. The equilibrium exchange rate rises, so more dollars must be exchanged for pounds. The dollar has depreciated.
33-17. Consider Figure 33-5. Suppose that the real interest rate in Britain increase relative to the U.S. real interest rate. What will happen to the equilibrium dollar price of the pound, and why? Does the dollar appreciate or depreciate in relation to the pound?
International investors now seek higher returns available from obtaining financial assets in Britain. Consequently, the quantity of pounds demanded increases at any given exchange rate, meaning that the demand curve for pounds shifts rightward. The equilibrium exchange rate increases, which means that more dollars must be exchanged for pounds. The dollar has depreciated.
33-18. Take a look at Figure 33-6. Suppose that the preferences of most British residents alter toward purchasing more downloaded online screaming videos of Hollywood movies distributed by U.S. firms. What will happen to the equilibrium dollar price of the pound, and why? Does the dollar appreciate or depreciate in relation to the pound?
To purchase additional streaming videos from U.S. firms, the British residents must obtain more dollars, so the quantity of pounds supplied in exchange for dollars increases at each possible exchange rate. Consequently, the supply curve in the figure shifts rightward, and the equilibrium dollar price of the pound decreases. The dollar appreciates.
33-19. Consider Figure 33-6. A sudden increase in economic and political instability throughout Europe and Asia has caused the United States to appear to British residents to be relatively more economically and politically more stable than was previously the case. What will happen to the equilibrium dollar price of the pound, and why? Does the dollar appreciate or depreciate in relation to the pound?
Because the United States now appears to be more economically and politically stable relative to Europe and Asia, more British residents will want to put their savings into U.S. assets instead of their own domestic assets. As a result, the supply curve in the figure shifts rightward, and the equilibrium dollar price of the pound decreases. The dollar appreciates.
33-20. Suppose the initially in Figure 33-8, the market for Bahrain’s currency, the dinar, is in equilibrium at point E1. Now, however, an increase in the U.S. real interest rate has occurred even as real interest rates in Bahrain and elsewhere in the world either have declined or have remained unchanged. What must Bahrain’s central bank do, and why, if it wishes to maintain a fixed exchange rate?
Bahrain’s residents seek to earn higher returns on U.S. assets and thereby sell more dinars for dollars at any given exchange rate. The supply curve shifts rightward, which otherwise would yield point E2. To prevent the exchange rate from falling, Bahrain’s central bank buys more dinars at any exchange rate and shifts the demand curve rightward. Point E3 results, and the exchange rate remains unchanged.
Selected References
Aghevli, B. B., “The Balance of Payments and the Money Supply Under the Gold Standard Regime:
U.S. 1879–1914,” American Economic Review, March 1975.
Baillie, R. and P. MacMahon, The Foreign Exchange Market, Cambridge: Cambridge University Press, 1989.
Bordo, Michael D., “The Classical Gold Standard; Some Lessons for Today,” Review (Federal Reserve Bank of St. Louis), May 1981, pp. 2–17.
Dreyer, Jacob S., Goffried Haberler, and Thomas D. Willett, Exchange Rate Flexibility, Washington, D.C.: American Enterprise Institute Publications, 1978.
Friedman, Milton, Dollars and Deficits, Englewood Cliffs, NJ: Prentice-Hall, 1968.
Hamouda, Omar F., Robin Rowley, and Bernard M. Wolf, eds., The Future of the International Monetary System, New York: M.E. Sharpe, 1989.
Hawtrey, R. G., The Gold Standard in Theory and Practice, London: Longmans, Green, 1947.
Hung, Juann, “Assessing the Exchange Rate’s Impact on U.S. Manufacturing Profits,” Federal Reserve Bank of New York Quarterly Review, Vol. 17, No. 4, Winter 1992–1993.
Lanyi, A., “The Case for Floating Exchange Rates Reconsidered,” Essays in International Finance,
No. 72, Princeton, NJ: Princeton University Press, 1969.
Root, Franklin R., International Trade and Investment, 6th ed., Cincinnati, OH: South-Western, 1990.
