Transcript International Finance and the Foreign Exchange

REVIEW:
1. If the exchange rate between the U.S. dollar and Mexican
peso fluctuates freely, indicate which of the following will
cause the dollar to appreciate or depreciate relative to the
peso.
(a) An increase in the quantity of drilling equipment purchased
in the U.S. by Pemex (the Mexican oil company) as a result
of a Mexican oil discovery?
(b) An increase in the U.S. purchase of crude from Mexico as a
result of development of Mexican oil fields?
(c) Higher real interest rates in Mexico, inducing U.S. citizens to
move their financial investments from U.S. to Mexican banks?
(d) Lower real interest rates in the U.S., inducing Mexican
investors to borrow dollars and then exchange them for pesos?
(e) Inflation in the United States and stable prices in Mexico?
(f) An economic boom in Mexico, inducing Mexicans to buy
more U.S.–made automobiles, trucks, appliances, and TV sets?
(g) Attractive investment opportunities, inducing U.S. investors to
buy stock in Mexican firms?
Chapter 38 Pt. II:
Macroeconomic Policy
&
Foreign Exchange
Fiscal Policy and the Exchange Rate:

An unanticipated shift to a more expansionary fiscal
policy (increase G spending or decrease taxes) will
tend to:
1. increases real interest rates
2. increases the inflow of capital
3. causes the current account to shift toward a deficit

A restrictive fiscal policy (decrease G spending or
increase taxes) will be the opposite:
1. lower interest rates
2. lowers outflow of capital
3. causes a current account surplus
Monetary Policy and the Exchange Rate:

An unanticipated shift to a more expansionary monetary
policy (buying bonds) will:
1. lowers interest rates
2. lowers the outflow of capital
3. causes currency depreciation and a trade surplus

A restrictive monetary policy (sell bonds) will be the
opposite:
1.
2.
3.
4.
raises the real interest rate
reduces the rate of inflation
causes currency appreciation
increases the inflow of capital and raises the trade deficit
Current Account Deficits & the Economy:

Under a flexible exchange rate system, an inflow of capital
implies a current account surplus.

An outflow of capital implies a current account deficit.

A trade deficit is NOT necessarily bad:
Fixed Exchange Rate: foreign exchange rates that
are pegged to some set value like gold or the U.S. dollar.
Examples of fixed rates:



within the European Union
The currencies of Hong Kong, Argentina, Ecuador, and Panama
are unified with the U.S. dollar (Kuwait in May 2007
abandoned the use of the dollar…)
China has had the Yuan pegged to the dollar since 1995 (8.28
yuan per dollar)