Question

2. Explain why you agree or disagree with each of the following statements:

a. "A nation's currency will depreciate if its inflation rate is less that that of its trading partners."

b. " A nations whose interest rate falls more rapidly than that of other nations can expect the exchange value of its currency to depreciate."

c. "A nation whose economy grows more slowly than its major trading partners can expect the exchange value of its currency to appreciate."

d. "A nation's currency will appreciate if its interest rate rises relative to that of its trading partners and its income level falls relative to that of its trading partners." -

If the exchange rate changes from $1.70 = 1 pound to $1.68 = 1 pound, what does this means for the dollar? For the pound? What if the exchange rate changes from $1.70 = 1 pound to $1.72 pound?

Answer 1

(2)

(a) FALSE

When a country's inflation rate is lower than inflation in its trading partners, exportable goods of that country become more competitive and so, export demand of that country rises, increasing demand for its domestic currency, which appreciates.

(b) TRUE

When interest rate is lower than interest rate in trading partners, investors lower their investment in the low-interest rate country, so demand for that country's currency falls, depreciating the domestic currency.

(c) TRUE

Slow growth rate will decrease import demand, thereby decreasing the demand for foreign currency, as a result of which, foreign currency will depreciate and domestic currency will appreciate.

(d) TRUE

When interest rate is higher than interest rate in trading partners, investors increase their investment in the higher-interest rate country, so demand for that country's currency rises, appreciating the domestic currency. At the same time, lower income level will decrease import demand, thereby decreasing the demand for foreign currency, as a result of which, foreign currency will depreciate and domestic currency will appreciate. The net effect is a definite appreciation of the domestic currency.

(3)

When exchange rate changes from $1.7 = 1 pound to $1.68 = 1 pound, Dollar appreciates and Pound depreciates.

When exchange rate changes from $1.7 = 1 pound to $1.72 = 1 pound, Dollar depreciates and Pound appreciates.