Foreign Exchange Market

Topics: Foreign exchange market, United States dollar, Currency Pages: 3 (790 words) Published: October 19, 2013
___ must choose can exchange rate system to determine how prices in the home country currency are converted into prices in another country’s currency (every country) •A managed floating exchange rate refers to (an exchange rate that is not pegged, but does not float freely) •A small country with strong economic ties to a larger country should (PEG ((HARD OR SOFT)) THEIR EXCHANGE RATE TO THE LARGER COUNTRY’S CURRENCY) •An increase in the real exchange rate (real depreciation of domestic currency) will result in (AN INCREASE IN NET EXPORTS) •China has pegged its currency against the U.S. dollar. If demand for dollars decreases (THERE IS PRESSURE FOR THE U.S. DOLLAR TO DEPRECIATE. IN THIS SETTING, CHINA HAS TO PURCHASE DOLLARS TO MAINTAIN ITS PEG) •Consider Figure 10.4, “Supply and Demand in the Foreign Exchange Market.” If U.S. demand for the British pound decreases, in the long run (THE DEMAND CURVE WILL SHIFT IN TO THE LEFT, AND THE DOLLAR WILL APPRECIATE) •If the U.S. dollar depreciates in terms of the Euro (American goods would be cheaper for Europeans) •In a fixed exchange rate system, how do countries address the problem of currency market pressures that threaten to lower or raise the value of their currency (a & b only: if demand rises, countries must fill the excess demand for foreign currency by selling their reserves, if demand falls, then countries must increase demand by buying up the excess supply with domestic currency) •In the debate on fixed versus floating exchange rates, the strongest argument for a floating rate is that it frees macroeconomic policy from taking care of the exchange rate. Why is this also the weakest argument (the freeing of monetary policy from the task of maintaining an exchange rate creates a lack of external discipline on monetary policy and leads to an over reliance on inflationary policies to satisfy domestic economic needs) •Suppose a bond issued by the European Central Bank and denominated in euros...
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