1. 2. C H A P T E R C H E C K L I S T. When you have completed your study of this chapter, you will be able to. Describe a countries balance of payments accounts and explain what determines the amount of international borrowing and lending.
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2C H A P T E R C H E C K L I S T
Explain how the exchange rate is determined and why it fluctuates.
1. If the exchange rate rises, the quantity of dollars demanded decreases along the demand curve for dollars.
2.If the exchange rate falls, the quantity of dollars demanded increases along the demand curve for dollars.
1. An increase in the demand for $’s
2. A decrease in the demand for $’s.
Note the symmetry with the factors that influence the demand for $’s – an unusual aspect of this market.
1. If the exchange rate rises, the quantity of $’s supplied increases along the supply curve for $’s.
2. If the exchange rate falls, the quantity of $’s supplied decreases along the supply curve for $’s.
1. An increase in the supply of dollars.
2. A decrease in the supply of dollars.
1. If the exchange rate is 120 yen per dollar, there is a surplus of dollars and the exchange rate falls.20.2 THE EXCHANGE RATE
2.If the exchange rate is 80 yen per dollar, there is a shortage of dollars and the exchange rate rises.
3.If the exchange rate is 100 yen per dollar, there is neither a shortage nor a surplus of $’s and the exchange rate remains constant.The market is in equilibrium.20.2 THE EXCHANGE RATE
1.Traders expected the $ to depreciate— the demand for U.S. $’s decreased and the supply of U.S. $’s increased.
2. The dollar depreciated.
1.Traders expected the $ to appreciate — the demand for U.S. $’s increased and the supply of U.S. $’s decreased.
2. The dollar appreciated.
If prices in the United States rise faster than prices in other countries, people will tend to expect the foreign exchange value of the U.S. dollar to fall to preserve rough purchasing power parity.
Demand for U.S. dollars will decrease and supply will increase.
The U.S. dollar exchange rate will fall.
The U.S. dollar depreciates.
So, the currency of a country with a more rapid inflation rate will tend to depreciate relative to the currencies of countries with slower inflation rates.
So, the currency of a country with a slower inflation rate will tend to appreciate relative to the currencies of countries with more rapid inflation rates.
1. If demand increases from D0 to D1, the Fed sells dollars to increase supply.
2. dollar.If demand decreases from D0 to D2, the Fed buys $’s to decrease supply. But to buy $’s, it must have foreign currency. It can create $’s to sell more, but it cannot create foreign currency. So intervention to keep an exchange rate up cannot be sustained.20.2 THE EXCHANGE RATE
Intervention in foreign exchange markets is asymmetric: a country can stop its currency appreciating by being willing to sell its own currency, but there are limits to its ability to stop its currency depreciating because it can run out of foreign currency with which to buy its own currency.
So-called foreign exchange crises usually involve a country having tried to prevent a depreciation, and then reaching a point where it can’t any more, so the value of that currency falls quickly.Exchange rate intervention