(g) Explain 2 possible economic consequences for the Euro zone if the Euro appreciates.
·Exports decrease as foreigners find the Euro Zone’s goods to be more expensive and Imports increase as an appreciating currency has more purchasing power.
·As the price of imports falls, costs of living will fall as does costs of imported raw materials, lowering production costs and reducing pressure on the Price Level.
·Exports decrease shifting AD leftward reducing the PL, reducing growth and increasing unemployment.
·Value of foreign debt may be reduced.
·FDI inflows may decrease as it becomes more expensive to purchase assets in the euro zone.
·FDI outflows may increase as it becomes less expensive to purchase assets outside of the euro zone.
(h) Calculate the quantity of EU € she will receive for her US$300, 000.
300000/1.2 = €250,000
The EU€ depreciates by 10% against the US$. Fearing further depreciation of the EU€ Tanya exchanges her EU€ for US$.
(I) Calculate, in US$ the loss made by Tanya as a result of these transactions.
Understand – If the € gets weaker that means the $ gets stronger – meaning that it takes less US$ to buy 1 €.
New Exchange Rate = €1 = US$ 1.20 x .9 = US$ 1.08
€250,000 can be exchanged for 250,000 x 1.08 = US$ 270,000
Loss = 270,000 – 300,000 = US$30,000
(j) Explain 2 reasons why a government might prefer a floating exchange rate system for its currency.
·Floating Exchange rate system allows for independent monetary policy. Interest rates can be set in order to influence AD without fear of disrupting the (fixed) exchange rate.
·Exchange Rate Policy can be used to affect macroeconomic variables, such as growth/inflation.
·If the current account deficit/surplus, the exchange rate will act as a self-regulating mechanism to restore balance.
·The Central bank does not need to purchase foreign reserves: (involving an opportunity cost) to be able to intervene in the Foreign Exchange Market.
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