Question

1. Imagine students could opt to have their student loans paid in euros. What would the long-term effect on the balance of payments be? Would it make a difference if the students immediately opted to do a year’s study as a foreign exchange student in the Eurozone?
2. 1) Using a diagram, show how the government can intervene in the forex market to maintain a fixed exchange rate. 2) When would it become necessary to devalue the currency?
3. Given the exchange rates between the UK pound and the US dollar and between the UK pound and the euro, how can the exchange rate between the euro and the dollar be calculated?

Answer 1

Imagine students could opt to have their student loans paid in euros. What would the long-term effect on the balance of payments be? Would it make a difference if the students immediately opted to do a year’s study as a foreign exchange student in the Eurozone?

If the students are from Canada and they decide to pay their loans in euros the demand for euros will go up. The Canadian Balance of payments will be affected since the transfer of payments to euros will impact the current account making it bigger. Depending on the tuition fees for international students and Europe’s normal education fees, the student would experience higher tuition fees if they were to study abroad. This is due to the Euro having a higher value than the Canadian dollar, therefore the students purchasing power with Canadian dollars are reduced when they travel to Europe and exchange their money to Euros.

Using a diagram, show how the government can intervene in the forex market to maintain a fixed exchange rate.

Government intervention in the forex market when attempting to maintain a fixed exchange rate would require fiscal policy in the form of an expansionary policy that would cause governments to borrow more, causing interest rates to rise. This maintenance of a fixed exchange rate would only work effectively in an open economy. Where there is a balance of payments surplus the government will intervene by buying foreign exchange reserves, and when there is a balance of payments deficit they will sell the reserves. This relationship can be observed in the graph below.

Given the exchange rates between the UK pound and the US dollar and between the UK pound and the euro, how can the exchange rate between the euro and the dollar be calculated?

This exchange rate can be calculated by using the relationships of the UK and US currency exchange rates and the UK to Euro exchange rates. For example, if 1 pound = $1.30 and 1 pound = 1.15 euro, then we know that 1 euro = $1.13.