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International Finance

Chapter

33CHAPTER CHECKLIST

Chapter 33 studies how nations keep their international accounts, what determines the balance of payments, and how the value of the dollar is determined in the foreign exchange market.

Describe a country’s balance of payments accounts and explain what determines the amount of international borrowing and lending.

There are three balance of payments accounts: the current account, the capital account, and the official settlements account. The current account balance equals exports minus imports, plus net interest and

transfers received from abroad. The capital account is a record of foreign investment in the United States minus U.S. investment abroad. The official settlements account is a record of the change in U.S. official reserves. The sum of the balances on the three accounts always equals zero. We pay for imports that exceed the value of our exports by borrowing from the rest of the world. A net borrower is a coun-try that is borrowing more from the rest of the world than it is lending to the rest of the world and a net lender is a country that is lending more to the rest of the world than it is borrowing from the rest of the world. A debtor nation is a country that during its entire history has borrowed more from the rest

of the world than it has lent to it and a creditor nation is a country that during its entire history has invested more in the rest of the world than other countries have invested in it. Net exports, X – M,

equals the sum of the private sector balance, S – I, and the government sector balance, NT − G.

Explain how the exchange rate is determined and why it fluctuates. Foreign currency is needed to buy goods or invest in another country. The foreign exchange rate is the price at which one currency exchanges for another. It is determined by demand and supply in the for-eign exchange market. The quantity of dollars demanded increases when the exchange rate falls. The demand for dollars changes and the demand curve for dollars shifts if the U.S. interest rate differential

or the expected future exchange rate changes. A rise in either increases the demand for dollars. The

quantity of dollars supplied increases when the exchange rate rises. The supply of dollars changes and the supply curve of dollars shifts if the U.S. interest rate differential or the expected future exchange rate changes. A rise in either decreases the supply of dollars. At the equilibrium exchange rate, the quantity of dollars demanded equals the quantity of dollars supplied. The exchange rate is volatile be-cause factors that change the demand also change the supply. Exchange rate expectations are influ-enced by purchasing power parity, a situation in which money buys the same amount of goods and services in different currencies, and interest rate parity, a situation in which the interest rate in one cur-

rency equals the interest rate in another currency once exchange rate changes are taken into account. The Fed and other central banks can intervene directly in the foreign exchange market by pegging the exchange rate. If the peg overvalues the exchange rate, the central bank runs out of foreign reserves; if

the peg undervalues the exchange rate, the central bank accumulates foreign reserves.

544 Part 11 . MACROECONOMIC POLICY


CHECKPOINT 33.1

Describe a country’s balance of payments accounts and explain what determines the amount of international borrowing and lending.

Quick Review • Current account balance The current ac-

count balance equals net exports plus net interest plus net transfers received from

abroad.

• Capital account balance The capital ac-count balance equals foreign investment in the United States minus U.S. invest-

ment abroad.

Additional Practice Problems 33.1 In 2006 the U.S. economy recorded the follow-ing transactions:

Imports of goods and services, $2,203 billion;

net interest, $36 billion; net transfers −$90 bil-

lion; decrease in U.S. official reserves, −$2 bil-

lion; exports of goods and services, $1,446 bil-

lion; statistical discrepancy −$18 billion; foreign

investment in the United States, $1,882 billion;

and, U.S. investment abroad, $1,055 billion.

a. Calculate the current account balance.

b. Calculate the capital account balance.

c. Calculate the official settlements account

balance.

d. To what do these balances sum?

e. Was the United States a debtor or a credi-

tor nation in 2006?

2. Suppose the official settlements account equals zero. In this case, what is the relationship be-tween the current account and the capital ac-count? Why does this relationship exist?

Solutions to Additional Practice Problems 33.1 1a. The current account balance equals exports

plus net interest plus net transfers minus im-ports. So the current account balance equals $1,446 billion + $36 billion + (−$90 billion) −

$2,203 billion = −$811 billion.

1b. The capital account balance equals foreign investment in the United States minus U.S.

investment abroad plus any statistical dis-crepancy. So the capital account balance equals $1,882 billion − $1,055 billion + (−$18

billion) = $809 billion.

1c. The official settlements account balance is

the negative of the change in U.S. official re-serves. When reserves decrease by $2 billion,

the official settlements account balance is $2

billion.

1d. Keep in mind that the sum of the current ac-

count, capital account, and official settle-ments account is zero. So, if the previous an-

swers are correct, they will sum to zero. For-tunately, they do: −$811 billion + $809 billion

+ $2 billion = $0.

1e. Interest payments reflect the value of out-

standing debts. The United States is a debtor nation because the value of interest pay-ments received from the rest of the world is

less than the value of interest payments made to the rest of the world.

2. If the official settlements account equals zero,

then the deficit in the current account equals the surplus in the capital account. Or, if the official settlements account equals zero, then the surplus in the current account equals the deficit in the capital account. This relationship exists because the sum of the current account,

capital account, and the official settlements ac-count equals zero. If the official settlements ac-count equals zero, the current account balance must equal the negative of the capital account balance.

Self Test 33.1 Fill in the blanks The ____ (current; capital; official settlements) account records payments for the imports of goods and services. The ____ (current; capital; official settlements) account records foreign in-

vestment in the United States minus U.S. in-

vestment abroad. The sum of the balances on

current account, capital account, and the official settlements account always equals ____ (zero;

Chapter 33 . International Finance 545


100 percent). The United States is a ____ (deb-tor; creditor) nation. The United States is bor-

rowing for ____ (consumption; investment).

True or false 1. If foreign investment in the United States in-

creases, and U.S. investment in the rest of the

world decreases, the current account shows an

increase in exports and a decrease in imports.

2. The official settlements account balance is

negative if U.S. official reserves increase.

3. If the United States has a surplus in its capi-

tal account and a deficit in its current ac-

count, the balance in its official settlements

account is zero.

4. At the present time, the United States has a

current account deficit.

5. The United States is a net lender and a deb-

tor nation.

6. If the United States started to run a current

account surplus that continued indefinitely, it would immediately become a net lender and would eventually become a creditor na-tion.

7. Net exports equals the private sector balance minus the government sector balance.

8. In 2006, U.S. borrowing from abroad fi-nanced investment.

Multiple choice 11. A country’s balance of payments accounts

records its

a. tax receipts and expenditures. b. tariffs and nontariff revenue and gov-

ernment purchases. c. international trading, borrowing, and

lending. d. its tariff receipts and what it pays in ta-

riffs to other nations.

e. international exports and imports and nothing else.

12. Which of the following are balance of pay-ments accounts?

i. capital account.

ii. tariff account.

iii. current account.

a. i only. b. ii only. c. iii only. d. i and iii.

e. ii and iii.

13. Which balance of payments account records payments for imports and receipts from ex-ports?

a. current account

b. capital account c. official settlements account

d. reserves account

e. trade account

14. The current account balance is equal to

a. imports − exports + net interest + net

transfers.

b. imports − exports + net interest − net

transfers.

c. exports − imports − net interest + net

transfers.

d. exports − imports + net interest + net

transfers.

e. exports − imports − net interest − net

transfers.

15. If an investment of $100 million from the

United Kingdom is made in the United

States, in the U.S balance of payments ac-counts the $100 million is listed as a ____

entry in the ____ account.

a. positive; current

b. negative; capital c. positive; capital d. negative; current

e. positive; official settlements



16. If the United States receives $200 billion of

foreign investment and at the same time in-

vests a total of $160 billion abroad, then the

U.S.

a. capital account balance increases by $40 billion.

b. current account must be in surplus. c. balance of payments must be negative.

d. capital account balance decreases by $40 billion.

e. official settlements account balance in-

creases by $40 billion.

17. In the balance of payments accounts, changes in U.S. official reserves are record-ed in the

a. current account.

b. capital account. c. official settlements account.

d. international currency account. e. international reserves account.

18. If a country has a current account balance of $100 billion and the official settlements

account balance is zero, then the country’s capital account balance must be

a. equal to $100 billion. b. positive but not necessarily equal to $100

billion.

c. equal to −$100 billion.

d. negative but not necessarily equal to −$100 billion.

e. zero.

19. A country that is borrowing more from the rest of the world than it is lending is called a

a. net lender.

b. net borrower.

c. net debtor.

d. net creditor.

e. net loaner country.

10. A debtor nation is a country that

a. borrows more from the rest of the world

than it lends to it.

b. lends more to the rest of the world than it

borrows from it.

c. during its entire history has invested more in the rest of the world than other

countries have invested in it.

d. during its entire history has borrowed more from the rest of the world than it

has lent to it.

e. during its entire history has consistently run a capital account deficit.

11. Comparing the U.S. balance of payments in 2008 to the rest of the world, we see that the

a. United States has the largest current ac-count surplus.

b. U.S. current account is similar in size to

most developed nations. c. United States has the largest capital ac-

count deficit.

d. United States has the largest current ac-count deficit.

e. U.S. current account is similar in size to

most developed nations and has a deficit.

12. According to the U.S. balance of payments accounts in 2008, U.S. international borrow-

ing is used for

a. private and public investment. b. private consumption.

c. government expenditure. d. private and public saving. e. private saving and public consumption.

Short answer and numeric questions 1. What is recorded in the U.S. current account?

In its capital account? In its official settle-ments account?

2. If its official settlements account equals zero, what will a country’s capital account equal if it has a $350 billion current account deficit?



Item (billions of dollars)U.S. investment abroad 400Exports of goods and services 1,000Net transfers 0Change in official reserves 10Net interest 0Foreign investment in the United States 800

3. The table above has balance of payment data for the United States.

a. What is the capital account balance?

b. What is the official settlements balance?

c. What is the current account balance?

d. What is the value of imports of goods and services?

4. What is a net borrower? A debtor nation? Is

it possible for a nation to be net borrower and yet not be a debtor nation?

Item (billions of dollars)Saving 1,600Investment 1,900Government expenditures 1,300Net taxes 1,400

5. The table above has data for the United

States.

a. What is the private sector balance?

b. What is the government sector balance?

c. What is net exports?

Additional Exercises (also in MyEconLab Test A) It is 2014, and the U.S. economy records the fol-

lowing transactions: Exports of goods and ser-vices, $1,800 billion; interest payments to the rest of the world, $550 billion; interest received

from the rest of the world, $350 billion; decrease

in U.S. official reserves, $10 billion; government sector balance, $200 billion; saving, $1,800 bil-lion; investment, $2,000 billion; net transfers are

zero.

1. Calculate the current account balance, the

capital account balance, the official settle-

ments account balance, and imports of goods and services.

2. Is the United States a debtor or creditor na-

tion in 2014?

3. If net taxes increase by $100 billion, what happens to the capital account balance?

CHECKPOINT 33.2

Explain how the exchange rate is determined and why it fluctuates.

Quick Review • U.S. interest rate differential In the foreign

exchange market, an increase in the U.S.

interest rate differential increases the

demand for dollars and decreases the

supply of dollars.

• Expected future exchange rate In the for-

eign exchange market, a rise in the ex-pected future exchange rate increases the demand for dollars and decreases the

supply of dollars.

Additional Practice Problems 33.2 1. The figure

shows the

supply and de-mand curves for

dollars in the

foreign ex-

change market.

a. What is the

equilibrium

exchange rate?

b. Suppose the U.S. interest rate rises so that

the U.S. interest rate differential increases.

Assume that the effect on the supply is the same as the effect on the demand. In the

figure, show the effect of this change. Does the equilibrium exchange rate rise or fall? Does the equilibrium quantity of dol-

lars exchanged increase or decrease?

2. How and why does an increase in the expected future exchange rate change the current de-mand for U.S. dollars and the demand curve

for dollars? How and why does an increase in the expected future exchange rate change the supply of U.S. dollars and the supply curve of dollars? What is the effect on the equilibrium exchange rate?



Solutions to Additional Practice Problems 33.2 1a. The figure shows that the initial equilibrium

exchange rate is 0.8 euros per dollar.

1b. The increase

in the U.S. in-

terest rate dif-

ferential in-

creases the

demand for

U.S. dollars

and simultan-

eously de-creases the

supply of U.S. dollars. As a

result the demand curve for dollars shifts

rightward, from D0 to D1 and the supply curve of dollars shifts leftward, from S0 to S1.

The exchange rate rises. In the figure the ex-change rate rises to 0.9 euros per dollar. Be-cause the effect on the demand is the same as

the effect on the supply, the curves shift by the same amount, so the equilibrium quantity

of dollars exchanged does not change.

2. An increase in the expected future exchange rate increases the demand for U.S. dollars

and shifts the demand curve rightward. The demand for U.S. dollars increases because at

the current exchange rate people want to buy U.S. dollars now and sell them in the future

at the higher expected exchange rate. An in-

crease in the expected future exchange rate decreases the supply of U.S. dollars and shifts the supply curve leftward. The supply of U.S. dollars decreases because people would rather keep the dollars until they can sell them in the future at the higher expected exchange rate. Because the demand for dol-

lars increases and the supply of dollars de-creases, the current equilibrium exchange rate rises.

Self Test 33.2 Fill in the blanks The price at which one currency exchanges for another is called a foreign ____ (exchange rate;

interest rate). If the dollar falls in value against the Mexican peso, the dollar has ____ (appre-ciated; depreciated). A rise in exchange rate ____ (decreases; increases) the quantity of U.S. dollars demanded. An increase in the demand

for dollars shifts the demand curve for dollars

____ (leftward; rightward) and an increase in

the supply of dollars shifts the supply curve of dollars ____ (leftward; rightward). The ex-change rate is volatile because an influence that changes the demand for dollars often ____ (changes; does not change) the supply of dol-

lars. An increase in the expected future ex-change rate ____ (raises; lowers) the equili-brium exchange rate. Purchasing power parity is equal value of ____ (interest rates; money). If the Fed buys dollars on the foreign exchange market, the exchange rate ____ (rises; falls).

True or false 1. The U.S. foreign exchange rate changes in-

frequently.

2. If the exchange rate increases from 0.9 euros

per dollar to 1.1 euros per dollar, the dollar has appreciated.

3. The larger the value of U.S. exports, the larg-er is the quantity of U.S. dollars demanded.

4. An increase in the U.S. exchange rate from

1.10 euros per dollar to 1.20 euros per dollar increases the supply of U.S. dollars and shifts

the supply curve of dollars rightward.

5. A rise in the expected future exchange rate increases the demand for dollars and also the

supply of dollars and might raise or lower the exchange rate.

6. The equilibrium U.S. exchange rate is the ex-change rate that sets the quantity of dollars demanded equal to the quantity of dollars supplied.

7. An increase in the U.S. interest rate differen-

tial raises the U.S. exchange rate.

8. To prevent the price of the euro from falling, the European Central Bank might sell euros on the foreign exchange market.



Multiple choice 1. The foreign exchange market is the market

in which

a. all international transactions occur.

b. currencies are exchanged solely by gov-ernments.

c. goods and services are exchanged be-tween governments.

d. the currency of one country is exchanged for the currency of another.

e. the world's governments collect their ta-riff revenue.

2. When Del Monte, an American company, purchases Mexican tomatoes, Del Monte

pays for the tomatoes with

a. Canadian dollars.

b. Mexican pesos.

c. gold. d. Mexican goods and services. e. euros.

3. If today the exchange rate is 1.00 euro per

dollar and tomorrow the exchange rate is 0.98 euros per dollar, then the dollar ____ and the euro____.

a. appreciated; appreciated

b. appreciated; depreciated

c. depreciated; appreciated

d. depreciated; depreciated

e. depreciated; did not change

4. In the foreign exchange market, as the U.S. exchange rate rises from 0.95 euros per dol-

lar to 1.05 euros per dollar, other things re-maining the same, the

a. quantity of dollars demanded increases. b. demand curve for dollars shifts

rightward.

c. demand curve for dollars shifts leftward.

d. quantity of dollars demanded decreases. e. supply curve of dollars shifts rightward.

5. In the foreign exchange market, the de-

mand for dollars increases and the demand

curve for dollars shifts rightward if the

a. U.S. interest rate differential increases.

b. expected future exchange rate falls. c. foreign interest rate rises. d. U.S. interest rate falls.

e. exchange rate falls.

6. As the exchange rate ____, the quantity of

U.S. dollars supplied ____.

a. rises; increases

b. falls; increases

c. falls; remains the same

d. rises; decreases

e. rises; remains the same

7. In the foreign exchange market, the supply curve of dollars is

a. upward sloping. b. downward sloping. c. vertical.

d. horizontal.

e. identical to the demand curve for dollars.

8. Everything else remaining the same, in the foreign exchange market which of the fol-

lowing increases the supply of U.S. dollars?

a. The European interest rate rises.

b. The expected future exchange rate rises. c. The U.S. interest rate rises.

d. The U.S. interest rate differential increas-

es.

e. The exchange rate falls.

9. When there is a shortage of dollars in the foreign exchange market, the

a. demand curve for dollars shifts leftward

to restore the equilibrium. b. U.S. exchange rate will appreciate. c. U.S. exchange rate will depreciate. d. supply curve of dollars shifts leftward to

restore the equilibrium. e. supply curve of dollars shifts rightward

to restore the equilibrium.



10. In the foreign exchange market, when the U.S. interest rate rises, the supply of dollars ____ and the foreign exchange rate ____.

a. increases; rises

b. increases; falls

c. decreases; rises

d. decreases; falls

e. increases; does not change

11. A situation in which money buys the same amount of goods and services in different currencies is called

a. exchange rate equilibrium. b. purchasing power parity. c. exchange rate surplus. d. exchange rate balance. e. a fixed exchange rate.

12. Interest rate parity occurs when

a. the interest rate in one currency equals the interest rate in another currency when exchange rate changes are taken in-

to account.

b. interest rate differentials are always maintained across nations.

c. interest rates are equal across nations. d. prices are equal across nations when ex-

change rates are taken into account. e. .

Complete the graph 1. Figure 33.1 shows the foreign exchange mar-

ket for U.S. dollars.

a. What is the equilibrium exchange rate?

b. The U.S. interest rate differential rises. In

Figure 33.1, illustrate the effect of this change. What happens to the exchange rate?

2. Figure 33.2 shows the foreign exchange mar-ket for U.S. dollars. Suppose people expect that the future exchange rate will be lower.

In Figure 33.2, illustrate the effect of this change. What happens to the exchange rate? Has the exchange rate appreciated or depre-ciated?

Short answer and numeric questions 1. If the exchange rate rises from 0.90 euros per

dollar to 1.00 euros per dollar, has the dollar appreciated or depreciated? Has the euro

appreciated or depreciated?

2. What is the relationship between the value of U.S. exports and the quantity of U.S. dollars

demanded? Why does this relationship exist?

3. What is the relationship between the value of U.S. imports and the quantity of U.S. dollars

supplied? Why does this relationship exist?

4. Everything else remaining the same, how will a rise in the European interest rate affect

the demand for dollars, the supply of dollars, and the U.S. exchange rate?



5. If the Fed believes the exchange rate is too low and wants to raise it, what action does

the Fed undertake in the foreign exchange market? What limits the extent to which the

Fed can undertake this action?

Additional Exercises (also in MyEconLab Test A) Use the following for the next 3 exercises. Sup-

pose that yesterday, the Canadian dollar ($C)

was trading on the foreign exchange market at $0.85 U.S. per $C. Today, the Canadian dollar is

trading at $0.80 U.S. per $C. 1. Which of the two currencies (the Canadian

dollar or the U.S. dollar) has appreciated and which has depreciated today?

2. List the events that could have caused to-

day’s change in the value of the Canadian dollar on the foreign exchange market. Did the events on you list increase or decrease the demand for Canadian dollars, the supply of Canadian dollars, or both the demand for

and supply of Canadian dollars?

3. If the Bank of Canada had tried to stabilize

the value of the Canadian dollar at $0.85

U.S., what action would it have taken? What

effect would the Bank of Canada’s actions

have had on Canadian official reserves?



SELF TEST ANSWERS

CHECKPOINT 33.1 Fill in the blanks The current account records payments for the imports of goods and services. The capital ac-count records foreign investment in the United

States minus U.S. investment abroad. The sum

of the balances on current account, capital ac-count, and the official settlements account al-

ways equals zero. The United States is a debtor

nation. The United States is borrowing for in-

vestment.

True or false 1. False; page 850

2. True; page 850

3. False; page 850

4. True; page 851

5. False; page 852

6. True; page 853

7. False; pages 854-855

8. True; page 855

Multiple choice 11. c; page 850

12. d; page 850

13. a; page 850

14. d; page 850

15. c; page 850

16. a; page 850

17. c; page 850

18. c; page 850

19. b; page 852

10. d; page 852

11. d; page 855

12. a; page 855

Short answer and numeric questions 1. The current account records payments for

imports, receipts from exports, net interest and net transfers received from abroad. The

capital account records foreign investment in the United States minus U.S. investments

abroad. The official settlements account

records changes in U.S. official reserves, the

government’s holding of foreign currency; page 850.

2. The current account balance plus the capital account balance plus official settlements ac-count balance sums to zero. So if the official

settlements account equals zero, a $350 bil-lion current account deficit means there is a

$350 billion capital account surplus; page 850.

3. a. The capital account balance equals foreign investment in the United States minus

U.S. investment abroad, which is $400 bil-

lion; pages 850-851.

b. The official settlements balance is the neg-

ative of the change in official reserves, or −$10 billion; pages 850-851.

c. The sum of the current account balance,

the capital account balance, and the offi-

cial settlements account balance is zero.

The capital account balance is $400 billion and the official settlements account bal-

ance is −$10 billion, so the current account

balance is −$390 billion; pages 850-851.

d. The current account balance equals ex-ports minus imports plus net interest plus net transfers received from abroad. Net in-

terest and net transfers are given as zero. The current account balance is −$390 bil-

lion and exports are $1,000 billion, so im-

ports equal $1,390 billion; pages 850-851.

4. A net borrower is a country that is borrow-ing more from the rest of the world than it is lending to the rest of the world. A debtor na-tion is a country that during its entire history has borrowed more from the rest of the

world than it has lent to it. It is possible for a nation to be a net borrower but not be a deb-

tor nation. A country can be a creditor nation and a net borrower. This situation occurs if a

creditor nation is, during a particular year, borrowing more from the rest of the world

than it is lending to the rest of the world; page 852.



5. a. The private sector balance equals saving minus investment, so the private sector balance is −$300 billion; page 855.

b. The government sector balance equals net taxes minus government expenditures on

goods and services, so the government sector balance is $100 billion; page 855.

c. The sum of the private sector balance plus the government sector balance equals net exports, so net exports equals −$200 bil-

lion; page 855.

Additional Exercises (also in MyEconLab Test A) 1. The current account balance equals net ex-

ports plus net interest (which is −$200 bil-

lion) plus net transfers (which is zero). Net exports equals the government sector bal-

ance ($200 billion) plus the private sector

balance. The private sector balance equals saving ($1,800 billion) minus investment ($2,000 billion), which is −$200 billion. So net

exports equals ($200 billion) + (−$200 billion)

= $0. So the current account balance equals −$200 billion.

The capital account equals −(current account

balance + official settlements account bal-

ance). The official settlements account equals $10 billion because official U.S. reserves de-

creased by $10 billion. So the capital account

balance equals −(−$200 billion + $10 billion) =

−(−$190 billion) = $190 billion.

The official settlements account balance is

$10 billion.

Net exports equal exports minus imports. Exports are $1,800 billion and net exports are −$200 billion, so imports = $2,000 billion; pages 850-851.

2. The United States is a debtor nation because

interest payments to the rest of the world ex-ceed interest payments to the United States; pages 852-853 .

3. If net taxes increase by $100 billion, the gov-ernment surplus increases by $100 billion and so the current account deficit shrinks.

With no change in the official settlements ac-

count balance, the capital account surplus de-creases; pages 854-855.

CHECKPOINT 33.2 Fill in the blanks The price at which one currency exchanges for another is called a foreign exchange rate. If the

dollar falls in value against the Mexican peso,

the dollar has depreciated. A rise in the ex-

change rate decreases the quantity of U.S. dol-

lars demanded. An increase in the demand for

dollars shifts the demand curve for dollars

rightward and an increase in the supply of dol-

lars shifts the supply curve of dollars rightward. The exchange rate is volatile because an influence that changes the demand for dol-

lars often changes the supply of dollars. An in-

crease in the expected future exchange rate raises the equilibrium exchange rate. Purchas-ing power parity is equal value of money. If the

Fed buys dollars on the foreign exchange mar-ket, the exchange rate rises.

True or false 1. False; page 857

2. True; page 857

3. True; page 858

4. False; page 862

5. False; pages 860, 863, 865

6. True; page 864

7. True; page 865

8. False; page 868

Multiple choice 11. d; page 857

12. b; page 857

13. c; pages 857-858

14. d; page 858

15. a; page 860

16. a; page 861

17. a; page 862

18. a; page 863

19. b; page 864

10. c; pages 863, 865

11. b; page 866

12. a; page 868



Complete the graph

1. a. The equilibrium exchange rate is 1.00 euro

per dollar; page 864.

b. The increase in the U.S. interest rate diffe-

rential increases the demand for dollars

and shifts the demand curve from D0 to D1

in Figure 33.3. The increase in the U.S. in-

terest rate differential also decreases the

supply of dollars and shifts the supply curve from S0 to S1. The exchange rate ris-es. In the figure, the exchange rate rises to 1.05 euros per dollar; pages 860, 863, 865.

2. The fall in the expected future exchange rate decreases the demand for dollars and in-

creases the supply of dollars. The demand curve shifts leftward from D0 to D1 and the

supply curve shifts rightward from S0 to S1.

The exchange falls from 1.00 euro per dollar to 0.95 euros per dollar in Figure 33.4. The

exchange rate depreciates; pages 860, 863,

865.

Short answer and numeric questions 1. When the exchange rate rises from 0.90 euros

per dollar to 1.00 euro per dollar, the dollar appreciates because the dollar buys more eu-

ros. The euro depreciates because it now takes 1 euro to buy a dollar instead of 0.9 eu-

ros to buy a dollar; pages 857-858.

2. The larger the value of U.S. exports, the larg-

er is the quantity of U.S. dollars demanded. This relationship exists because U.S. firms want to be paid for their goods and services in dollars; page 858.

3. The larger the value of U.S. imports, the larger the quantity of U.S. dollars supplied. This relationship exists because U.S. con-

sumers must pay for their imports in foreign currency. To obtain foreign currency, U.S. consumers supply dollars; page 861.

4. An increase in the European interest rate de-

creases the U.S. interest rate differential. The

smaller the U.S. interest rate differential, the

smaller is the demand for U.S. assets and the

smaller the demand for dollars. And the

smaller the U.S. interest rate differential, the

greater is the demand for foreign assets and the greater is the supply of dollars. So when the European interest rate rises, the demand

for dollars decreases, the supply of dollars increases, and the equilibrium exchange rate falls; pages 860, 863, 865.

5. If the Fed wants to raise the exchange rate, it will buy dollars. The Fed would have to sell U.S. official reserves to buy dollars. The Fed is limited by its quantity of official reserves. If the Fed persisted in this action, eventually it would run out of reserves and would be

forced to stop buying dollars; page 868.



Additional Exercises (also in MyEconLab Test A) 1. Yesterday a Canadian dollar purchased 85

U.S. cents; today a Canadian dollar buys on-

ly 80 U.S. cents. The Canadian dollar buys fewer U.S. cents and so the Canadian dollar

has depreciated. The U.S. dollar has appre-ciated; pages 857-858.

2. The main events that might have caused the appreciation of the U.S. dollar and the depre-ciation of the Canadian dollar are an increase

in the U.S. interest rate, a decrease in the Ca-

nadian interest rate, or concern that the Ca-

nadian dollar will depreciate (the U.S. dollar will appreciate) even more in the future.

The foreign exchange market is unlike other markets because the factors that affect the

supply also affect the demand. So the factors

listed in part (b) all affected both the demand for Canadian dollars as well as the supply of Canadian dollars. All the factors listed de-

creased the demand for Canadian dollars

and increased the supply; pages 859-860,

862-863.

3. To stabilize the value of the Canadian dollar

at 85 U.S. cents, the Bank of Canada would

have needed to decrease the supply of Cana-dian dollars. The Bank of Canada would

have needed to buy Canadian dollars.

When the Bank of Canada buys Canadian dollars, it decreases Canadian official re-

serves; pages 868-869.

CHAPTER CHECKLIST determines the amount of international ...risapmacro.weebly.com/uploads/5/6/3/2/56324515/... · International Finance 33Chapter CHAPTER CHECKLIST Describe a country’s

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