Economics (McConnell), 18th Edition

Chapter 38: The Balance of Payments, Exchange Rates, and Trade Deficits

Key Questions

1. Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets:

1. A U.S. airline firm purchases several Airbus planes assembled in France.
2. A German automobile firm decides to build an assembly plant in South Carolina.
3. A U.S. college student decides to spend a year studying at the Sorbonne in Paris.
4. An Italian manufacturer ships machinery from one Italian port to another on a Liberian freighter.
5. The U.S economy grows faster than the French economy.
6. A U.S government bond held by a Spanish citizen matures, and the loan amount is paid back to that person.
7. It is widely believed that the euro will depreciate in the near future.

2. Alpha's balance of payments data for 2008 are shown below. All figures are in billions of dollars. What are the (a) balance on goods, (b) balance on goods and services, (c) balance on current account, and (d) balance on capital and financial account? Suppose Alpha needed to deposit $10 billion of official reserves into the capital and financial account to balance it against the current account. Does Alpha have a balance-of-payments deficit or surplus? Explain.

3. Explain why the U.S. demand for Mexican pesos is downward-sloping and the supply of pesos to Americans is upward-sloping. Assuming a system of flexible exchange rates between Mexico and the United States, indicate whether each of the following would cause the Mexican peso to appreciate or depreciate:

1. The United States unilaterally reduces tariffs on Mexican products.
2. Mexico encounters severe inflation.
3. Deteriorating political relations reduce American tourism in Mexico.
4. The U.S economy moves into a severe recession.
5. The United States engages in a high-interest-rate monetary policy.
6. Mexican products become more fashionable to U.S. consumers.
7. The Mexican government encourages U.S. firms to invest in Mexican oil fields.
8. The rate of productivity growth in the United States diminishes sharply.

4. Diagram a market in which the equilibrium dollar price of 1 unit of fictitious currency zee (Z) is $5 (the exchange rate is $5 = Z1). Then show on your diagram a decline in the demand for Zee.

1. Referring to your diagram, discuss the adjustment options the United States would have in maintaining the exchange rate at $5 = Z1 under a fixed-exchange-rate system.
2. How would the U.S. balance-of-payments surplus that is created (by the decline in demand) get resolved under a system of flexible exchange rates?

5. Suppose that a country follows a managed-float policy but that its exchange rate is currently floating freely. In addition, suppose that it currently has a massive current account deficit. Does it also have a balance of payments deficit? If it decides to engage in a currency manipulation in order to reduce the size of its current account deficit, will it buy or sell its own currency? As it does so, what will happen to its official reserves of foreign currencies? Will they get larger or smaller? And, finally, will the country have a balance of payments deficit while it is manipulating the exchange rate?

Chapter 38 Key Question Solutions (108.0K)