Deck 19: International Finance and the Foreign Exchange Market

Question 1

If taxes imposed on personal and corporate income increased substantially in the United States and the monetary policy of the United States was less stable and more inflationary than other countries, how would these policies affect the trade deficit Why

Answer 1

The current account measures all the exports and imports in merchandise goods and services, investment income and unilateral transfers. The capital accounts measures the loans to and from foreigners and investment of domestic consumers abroad. The official reserve is the transaction of official reserve to maintain the pegged exchange rate regime. Under flexible exchange rate the official reserve is zero.
The source of inflow of capital and its use in domestic economy determines the future of the dependence on foreign capital. As long as the investment is not used to increase current consumption and instead are being used in investment projects, the foreign capital info will prove beneficial. The use of capital in productive measure increases the future income and accelerates growth. If the inflow of capital came to a halt this will retard the economic growth and will decrease future income.
Under flexible exchange rate system total sales to the foreigner must equal total receipt from them. Then at equilibrium the sum total of capital and current account must equal to zero. The inflow of capital shifts the capital account towards surplus. Then, the current account must have equal amount of deficit, to make the sum total zero. Therefore, the inflow of foreign investment increases the current account deficit.
On the other hand, the increase in tax rate, unstable money market and rising inflation will cause the foreign investor to shift their investment elsewhere. This will cause a net outflow of capital and shits the current account balance towards surplus or decrease the trade deficit.

Question 2

If foreigners have confidence in the U.S. economy and therefore move to expand their investments in the United States, how will the U.S. current-account balance be affected How will the exchange-rate value of the dollar be affected

Answer 2

The current account measures all the exports and imports in merchandise goods and services, investment income and unilateral transfers. The capital accounts measures the loans to and from foreigners and investment of domestic consumers abroad. The official reserve is the transaction of official reserve to maintain the pegged exchange rate regime. Under flexible exchange rate the official reserve is zero.
The source of inflow of capital and its use in domestic economy determines the future of the dependence on foreign capital. As long as the investment is not used to increase current consumption and instead are being used in investment projects, the foreign capital info will prove beneficial. The use of capital in productive measure increases the future income and accelerates growth. If the inflow of capital came to a halt this will retard the economic growth and will decrease future income.
Under flexible exchange rate system total sales to the foreigner must equal total receipt from them. Then at equilibrium the sum total of capital and current account must equal to zero. The inflow of capital shifts the capital account towards surplus. Then, the current account must have equal amount of deficit, to make the sum total zero. Therefore, the inflow of foreign investment increases the current account deficit.
As foreign investors invest in domestic market, they will need domestic currency and will supply foreign currency in the exchange rate market. The increase in supply will decrease the dollar value of foreign currency and will cause it to appreciate.

Question 3

Is a trade surplus indicative of a strong, healthy economy Why or why not

Answer 3

The current account measures all the exports and imports in merchandise goods and services, investment income and unilateral transfers. The capital accounts measures the loans to and from foreigners and investment of domestic consumers abroad. The official reserve is the transaction of official reserve to maintain the pegged exchange rate regime. Under flexible exchange rate the official reserve is zero.
The source of inflow of capital and its use in domestic economy determines the future of the dependence on foreign capital. As long as the investment is not used to increase current consumption and instead are being used in investment projects, the foreign capital info will prove beneficial. The use of capital in productive measure increases the future income and accelerates growth. If the inflow of capital came to a halt this will retard the economic growth and will decrease future income.
Under flexible exchange rate system total sales to the foreigner must equal total receipt from them. Then at equilibrium the sum total of capital and current account must equal to zero. The inflow of capital shifts the capital account towards surplus. Then, the current account must have equal amount of deficit, to make the sum total zero. Therefore, the inflow of foreign investment increases the current account deficit.
On the other hand, the increase in tax rate, unstable money market and rising inflation will cause the foreign investor to shift their investment elsewhere. This will cause a net outflow of capital and shits the current account balance towards surplus. Therefore, the trade surplus or current account surplus is not indicative of stronger and healthy economy.

Question 4

"Changes in exchange rates will automatically direct a country to a current-account balance under a flexible exchange rate system." Is this statement true or false

Question 5

Several members of Congress have been highly critical of Japan and China because U.S. imports from these countries have persistently been substantially greater than our exports to them.
a. Under a flexible exchange rate system, is there any reason to expect that the imports from a given country will tend to equal the exports to that country
b. Can you think of any reason why the United States might persistently run a trade deficit with these countries

Question 6

In recent years, the central banks of both Japan and China have purchased large amounts of U.S. Treasury bonds. These purchases increase the exchange rate value of the dollar relative to the Japanese yen and Chinese yuan. Are these purchases harmful to the U.S. economy Why or why not

Question 7

If the dollar depreciates relative to the Japanese yen, how will this affect the dollar price of a Japanese camera produced by Nikon, for example How will this change influence the quantity of Nikon cameras purchased by Americans

Question 8

How will the purchases of items from foreigners compare with the sales of items to foreigners when the foreign exchange market is in equilibrium Explain.

Question 9

Will a flexible exchange rate bring the imports of goods and services into balance with the exports of goods and services Why or why not

Question 10

The accompanying chart indicates an actual newspaper quotation of the exchange rate of various currencies. On FebruarY₂, did the dollar appreciate or depreciate against the British pound How did it fare against the Canadian dollar

Question 11

Suppose the exchange rate between the United States and Mexico freely fluctuates in the open market. Indicate whether each of the following would cause the dollar to appreciate or depreciate relative to the peso.
a. an increase in the quantity of drilling equipment purchased in the United States by Pemex, the Mexican oil company, as a result of a Mexican oil discovery
b. an increase in the U.S. purchase of crude oil from Mexico as a result of the development of Mexican oil fields c. higher real interest rates in Mexico, inducing U.S. citizens to move some of their financial investments from U.S. to Mexican banks
d. lower real interest rates in the United States, 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 increase in the inflation rate from 2 percent to 10 percent in both the United States and Mexico
g. an economic boom in Mexico, inducing Mexicans to buy more U.S.-made automobiles, trucks, electric appliances, and manufacturing equipment
h. attractive investment opportunities in Mexico, inducing U.S. investors to buy stock in Mexican firms

Question 12

Explain why the current-account balance and capitalaccount balance must sum to zero under a pure flexible rate system.

Question 13

Rapidly growing strong economies often experience trade deficits, whereas economies with sluggish growth often have trade surpluses. Can you explain this puzzle

Question 14

In recent years, a substantial share of the domestic capital formation in the United States has been fi- nanced by foreign investors. Is this dependence on foreign capital dangerous What would happen if the inflow of foreign capital came to a halt

Question 15

Suppose that the United States were running a current- account deficit. How would each of the following changes influence the size of the current-account deficit
a. a recession in the United States
b. a decline in the attractiveness of investment opportunities in the United States
c. an improvement in investment opportunities abroad