Briefly explain how each of the following would likely affect the value of the dollar and...

Briefly explain how each of the following would likely affect the value of the dollar and the exchange rate, all else being equal. (Please answer for all 5!)

1. U.S. consumers increase their spending on imported goods.

2. The Federal Reserve reports that it is less concerned about inflation and more concerned about the impending recession in the United States.

3. The U.S. government imposes a large tariff on imported automobiles.

4. The Federal Reserve raised interest rates fearing inflationary pressures due to the booming economy.

5. Both the U.S. and the European Union agreed with the WTO to abide by the free trade agreements. (Here, assume that the U.S. and the E.U. are sole trading partners.)

Solutions

Expert Solution

(1) Higher import demand by US consumers will increase the demand for foreign currency and decrease the demand for dollar. Demand curve for dollar shifts left. At the same time, supply of dollar will rise. Supply curve for dollar shifts right. Value of dollar will fall (dollar will depreciate) and exchange rate will fall, as the net effect.

(2) Fed's concern about recession will decrease import demand by US consumers, which will decrease the demand for foreign currency, and decrease the supply of dollar. Supply curve for dollar shifts left. Value of dollar will rise (dollar will appreciate) and exchange rate will rise.

(3) Higher tariff on imported cars will increase US domestic price of imported cars, decreasing demand for imported cars. This will decrease the demand for foreign currency, and decrease the supply of dollar. Supply curve for dollar shifts left. Value of dollar will rise (dollar will appreciate) and exchange rate will rise.

(4) Higher US interest rate will increase foreign investment in US, increasing demand for dollars and shifting dollar demand curve rightward. Value of dollar will rise (dollar will appreciate) and exchange rate will rise.

(5) US FTA with EU will increase both US exports to EU, and US imports from EU. The net effect on US net exports is uncertain. If US exports more than it imports, demand for dollar will rise, shifting dollar demand curve rightward, which will increase the value of dollar (appreciating dollar) and increasing exchange rate. If US imports more than it exports, demand for dollar will fall, shifting dollar demand curve leftward, which will decrease the value of dollar (depreciating dollar) and decreasing exchange rate.

Rahul Sunny answered 10 months ago

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