Currency Wars: Why depreciate currency? A depreciated currency attracts foreign buyers of domestically made goods and services This is because the foreign currency is now “stronger” relative to your weaker currency  Foreign households buy more  Domestic households buy fewer foreign goods Depreciation = more exports, fewer imports =  AD Appreciation = more imports, fewer exports =  AD

Mod. 43 & Mod. 44 Fixed vs Floating Exchange Rate: Fixed: holding a constant or near a target exchange rate Example: Hong Kong’s ER always targeted at HK 7.80/UDS Floating: Free floating exchange rate set by market place Is having a fixed or free floating exchange rate better? Strengths to both Fixed makes transactions easier Eliminates uncertainty Creates a more stable currency (free of government interference) Costs: Gov’ts must holds currencies to enact policy (low returns on investment) Corruption

Tools to Achieve Target: 1.Buy or sell its own currency (utilizing Foreign Exchange Reserves) with USD 2. Central Bank changing interest rates using expansionary or contractionary monetary policy 3.Affect supply or demand (in FOREX) by issuing licenses to buy or sell their currency

Fixed ER Policy: Surplus How can an ER be fixed? Assuming Surplus… 3 tools to keep targeted ER: Buy it’s own currency in FOREX using USD it owns (FOREX Reserves) causing appreciation Central bank increases interest rates (contractionary monetary policy = sell) causing appreciation Increase demand for currency in FOREX Reduce supply of currency in FOREX causing appreciation Use licensing system called FOREIGN EXCHANGE CONTROLS Quantity (HK) UDS/HK S D ER Targeted ER EQ *Surplus created as a result of fixed exchange rate **Surplus eliminated by enacting policy to appreciate HK ***Revaluation

Fixed ER Policy: Shortage *shortage created by Fixed policy **Shortage eliminate by policy depreciating HK ***Devaluation 3 tools the same, just used in opposite measures… Sell KH in FOREX causing depreciation Reduce interest rates, expansionary monetary policy (buy bonds), Increase supply of HK or reduce demand both causing depreciation Impose FOREIGN EXCHANGE CONTROLS and limit buyer of HK in FOREX Quantity (HK) UDS/HK S D ER Targeted ER EQ

FRQ Macro Exam 2014

Answers 2014 a. US exports increase (price level fall signals cheaper goods) b. i.US current account will be in a surplus (exports increasing so $ coming in) ii.Real GDP in SR will increase (exports positive component of AD) c. Demand for USD will increase (Korean households need USD to buy US goods) Ultimately, USD appreciates.

FRQ Macro Exam 2011

Answer 2011 a.i. LFS increases (increased foreign Investment = capital inflows) lowering Real IR ii.Decreased IR spurs investment, Increasing AD, thus lowering Unemployment in the SR b. i.Demand for Canadian dollar will increase (desire to invest in Canadian assets) ***OR in market for Pesos, SUPPLY of CD falls Leading to an appreciation of CD ii. Canadian exports to Mexico will decrease as the Canadian dollar appreciates…value has increased Making it more expensive for Mexican houeholds