Question

a. Suppose that the rest of the world goes through an economic recession. Show graphically and explain what happens to exchange rates and net exports.

b. If we assume that there are two economies that are trading parties. When one of them goes through an economic recession show graphically how this business cycle is transmitted to the other country.

c. Following the Great Recession the U.S. Federal Reserve decreased interest rate targets drastically. Show graphically and explain what happens to exchange rates and net exports as a result of this policy.

d. Show graphically what impact the U.S.’s Federal Reserve policies had on the economies of their trading partners.

Answer 1

A. if the rest of the world goes through an economic recession compared to the country in question, then interest rates in those countries will fall. This would make the ROW less attractive to save money. So money flows are less likely to leave ROW and move to the country in question that has higher interest rate. People from ROW will sell their currencies to buy currency of this country which has higher interest rate. So, currency of this country will appreciate and currency will depreciate in ROW. Increase in exchange rate in the country in question will make residents of this country to buy more goods from the ROW because those goods are cheaper now. But people from ROW will demand less goods from this country because the goods in this country are costly now as currency in this country has appreciates. So, in this country import increases and export falls, so net export (export - import) will decrease.