Question

8

a. Consider the following statement: “A country that grows faster than its major trading partners can expect the international value of its currency to depreciate.” This statement is

• false. High economic growth rates will increase real income and imports, lowering the demand for foreign currency, causing the value of the domestic currency to decline.

• true. High economic growth rates will increase real income and imports, lowering the demand for domestic currency, causing the value of the domestic currency to decline.

• false. High economic growth rates will increase real income and imports, lowering the demand for domestic currency, causing the value of the domestic currency to decline.

• true. High economic growth rates will increase real income and imports, lowering the demand for foreign currency, causing the value of the domestic currency to decline.

b. Consider the following statement: “A nation whose interest rate is rising more rapidly than interest rates in other nations can expect the international value of its currency to appreciate.” This statement is

• true. If domestic real interest rates are increasing more quickly than those in other countries, foreign financial investment will be attracted to the country, causing a rise in demand for foreign currency and an appreciation of the country’s currency.

• false. If domestic real interest rates are increasing more quickly than those in other countries, foreign financial investment will be attracted to the country, causing a rise in demand for foreign currency and an appreciation of the country’s currency.

• true. If domestic real interest rates are increasing more quickly than those in other countries, foreign financial investment will be attracted to the country, causing a rise in the supply of foreign currency and an appreciation of the country’s currency.

• false. If domestic real interest rates are increasing more quickly than those in other countries, foreign financial investment will be attracted to the country, causing a rise in the supply of foreign currency and a depreciation of the country’s currency.

c. Consider the following statement: “A country’s currency will appreciate if its inflation rate is less than that of the rest of the world.” This statement is

• true. If a country’s inflation rate is lower than rates in other countries, the domestic prices of foreign imports will decrease relative to domestically made goods, decreasing the demand for foreign currency.

• false.If a country’s inflation rate is lower than rates in other countries, the foreign prices of its products will decline relative to foreign-made products, increasing exports and supply of foreign currency, causing the country’s currency to appreciate.

• true. If a country’s inflation rate is lower than rates in other countries, the foreign prices of its products will decline relative to foreign-made products, increasing exports and supply of foreign currency, causing the country’s currency to appreciate.

• false. If a country’s inflation rate is lower than rates in other countries, the domestic prices of foreign imports will decrease relative to domestically made goods, decreasing the demand for foreign currency.

Answer 1

Answer A.

False. High economic growth rates will increase real income and imports, lowering the demand for foreign currency, causing the value of the domestic currency to decline.

Explanation - When economic growth is robust, the real income increases and this translates into higher consumption of goods and services. As imports increases, the demand for the local currency increases. In addition, strong economic growth also implies healthy investment flow in the country that makes the currency stronger.

Answer B.

True. If domestic real interest rates are increasing more quickly than those in other countries, foreign financial investment will be attracted to the country, causing a rise in the supply of foreign currency and an appreciation of the country’s currency.

Explanation - When interest rates are higher, investments flow into the country. The result is that foreign investors demand local currency and sell the foreign currency. As local currency is needed for investments. Therefore, supply of foreign currency rises and the foreign currency depreciates while the local currency appreciates.

Answer C.

True. If a country’s inflation rate is lower than rates in other countries, the foreign prices of its products will decline relative to foreign-made products, increasing exports and supply of foreign currency, causing the country’s currency to appreciate.

Explanation - When inflation is low for a broad range of goods and services, the locally produced goods become more competitive in the foreign market and the country gains comparative advantage. With boost in exports and a trade surplus, the currency appreciates.