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Lesson53 OA Exchange Rate Policy ANSWERS

The document discusses exchange rate policy and foreign exchange markets. It provides examples of how different policy changes by China or other countries could impact disequilibriums in currency markets. These include allowing currency appreciation, restricting foreign investment, and removing restrictions on domestic investment. It also examines how changes in trade policies, interest rates, and other economic reports could affect the value of currencies. Graphs and analyses are presented to illustrate surpluses and shortages created by fixed exchange rates and how buying or selling currency and engaging in open market operations could bring rates back to equilibrium.

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Daniela Gonzalez Sanchez
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126 views3 pages

Lesson53 OA Exchange Rate Policy ANSWERS

The document discusses exchange rate policy and foreign exchange markets. It provides examples of how different policy changes by China or other countries could impact disequilibriums in currency markets. These include allowing currency appreciation, restricting foreign investment, and removing restrictions on domestic investment. It also examines how changes in trade policies, interest rates, and other economic reports could affect the value of currencies. Graphs and analyses are presented to illustrate surpluses and shortages created by fixed exchange rates and how buying or selling currency and engaging in open market operations could bring rates back to equilibrium.

Uploaded by

Daniela Gonzalez Sanchez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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Exchange Rate Policy

Problem Set

1. Given the foreign exchange situation of China in the graph to the right, show how each of the following policy
changes might eliminate the disequilibrium in the market.
a. An appreciation of the yuan.
If the exchange rate were allowed to move freely, the U.S. dollar
price of the exchange rate would move toward the equilibrium
exchange rate (labeled XR* in the accompanying diagram). This
would occur as a result of the shortage, when buyers of the yuan
would bid up its U.S. dollar price. As the exchange rate
increases, the quantity of yuan demanded would fall and the
quantity of yuan supplied would increase. If the exchange rate
were to increase to XR* , the disequilibrium would be entirely
eliminated.

b. Placing restrictions on foreigners who want to invest in China.


Placing restrictions on foreigners who want to invest in China
would reduce the demand for the yuan, causing demand curve to
shift in the accompanying diagram from D 1 to something like D 2.
This would cause a reduction in the shortage of the yuan. If
demand fell to D 3, the disequilibrium would be completely
eliminated.

c. Removing restrictions on Chinese who want to invest abroad.


Removing restrictions on Chinese who wish to invest abroad
would cause an increase in the supply of the yuan and a
rightward shift in the supply curve. This increase in supply would
also cause reduction in the size of the shortage. If, for example,
supply increased from S 1 to S 2, the disequilibrium would be
eliminated completely in the accompanying diagram.

d. Imposing taxes on Chinese exports, such as shipments of clothing that are causing a political backlash in the
importing countries.
Imposing a tax on exports (Chinese goods sold to foreigners) would raise the price of these goods and
decrease the amount of Chinese goods purchased. This would also decrease the demand for the yuan.
The graphical analysis here is virtually identical to that found in the figure accompanying part b.
2. Suppose the United States and Japan are the only two trading countries in the world. What will happen to the value
of the U.S. dollar if the following occur, other things equal?
a. Japan relaxes some of its import restrictions.
If Japan relaxes import restrictions, Japanese residents will demand more U.S. goods and more U.S.
dollars to buy those goods. The U.S. dollar will appreciate due to the increase in the demand for U.S.
dollars.
b. The United States imposes some import tariffs on Japanese goods.
If the United States imposes import restrictions, Americans will buy fewer Japanese goods. Americans
will want to exchange fewer U.S. dollars for yen, so the supply of U.S. dollars will decrease and the U.S.
dollar will appreciate.
c. Interest rates in the United States rise dramatically.
A dramatic rise in U.S. interest rates will attract Japanese buyers of American assets as well as
discourage Americans from buying Japanese assets. There will be an increase in the demand for U.S.
dollars and a decrease in the supply of U.S. dollars; the U.S. dollar will appreciate.
d. A report indicates that Japanese cars last much longer than previously thought, especially compared with
American cars.
A report indicating that Japanese cars last much longer than previously thought, especially when
compared with American cars, will increase the demand for Japanese cars and the demand for Japanese
yen. The yen will appreciate and the U.S. dollar will depreciate.

3. Suppose the United States and China were the only two countries in the world.
a. Draw a correctly labeled graph of the foreign exchange market for U.S. dollars showing the equilibrium in the
market. The currency in China is the yuan.

 (1 point) The vertical axis is labeled “Exchange rate (Chinese yuan per U.S. dollar)” and the
horizontal axis is labeled “Quantity of U.S. dollars.”
 (1 point) Demand is downward sloping and labeled, supply is upward sloping and labeled.
 (1 point) The equilibrium exchange rate and the quantity of dollars are labeled on the axes at the
point where the supply and demand curves intersect.
b. On your graph, indicate a fixed exchange rate set below the equilibrium exchange rate. Does the fixed exchange
rate lead to a surplus or shortage of U.S. dollars? Explain and show the amount of the surplus/shortage on your

 (1 point) The fixed exchange rate level is depicted below the equilibrium exchange rate.
 (1 point) Shortage
 (1 point) The quantity demanded exceeds the quantity supplied at the higher fixed exchange rate.
 (1 point) The shortage is labeled as the horizontal distance between the supply and demand curves
at the fixed exchange rate.

c. To bring the foreign exchange market back to an equilibrium at the fixed exchange rate, would the U.S.
government need to buy or sell dollars? On your graph, illustrate how the government buying or selling dollars
would bring the equilibrium exchange rate back to the desired fixed rate.

 (1 point) Sell
 (1 point) The new supply curve is shown to the right of the old supply curve, crossing the demand
curve at the fixed exchange rate.

d. Suppose that instead of buying or selling dollars, the Federal Reserve was going to engage in monetary policy
to bring the foreign exchange market back to an equilibrium at the fixed exchange rate. Should the Fed buy or
sell Treasury securities in an open-market operation? Explain.
 (1 point) Buy Treasuries
 (1 point) Expansion of the money supply decreases interest rates in the U.S. This will reduce the
demand for the dollar and increase the supply of the dollar. The price of the dollar will begin to fall.

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