Questions and Answers
What is the formula to find the change in Home's effective exchange rate?
What does Home's effective exchange rate change by when (-10% × 40%) + (30% × 60%)?
What is the percentage change in the value of the U.S. dollar against a basket of 7 major currencies by early 2008?
Why did the dollar lose less value against a broad basket of 26 currencies compared to a basket of 7 major currencies?
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What is the term for a system in which the exchange rate is fixed, but is allowed to fluctuate within a narrow band?
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What is the term for a system in which a country adopts the currency of another country as its own official currency?
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What is the term for the exchange rate of one currency in terms of another?
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What is the term for the exchange rate that takes into account the currencies of multiple countries?
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What is the formula to find the change in the home country's effective exchange rate when there are N currencies in the basket?
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Study Notes
Dollarization
- Dollarization occurred in Ecuador in 2000, where a country unilaterally adopts the currency of another country.
Foreign Exchange Market
- The foreign exchange market (forex or FX market) is where exchange rates are set globally.
- The forex market is not an organized exchange and trades are conducted "over the counter" and in many locations.
- In April 2019, the global forex market traded $6.6 trillion per day, which is 29% more than in 2016, over three times more than in 2004, and over six times more than in 1992.
- Major foreign exchange centers include London, New York, Singapore, and Hong Kong.
- Other important centers for forex trade include Tokyo, Zurich, Paris, and Frankfurt.
Exchange Rate Behavior
- The U.S. dollar is in a floating relationship with the yen, the pound, and the Canadian dollar.
- The U.S. dollar is subject to a great deal of volatility due to its floating regime.
- The euro was introduced in 1999 and floats against the pound and the yen.
- The Danish krone provides an example of a fixed exchange rate.
Effective Exchange Rate
- The effective exchange rate is the weighted average of bilateral nominal exchange rate changes.
- The formula to calculate the effective exchange rate is: ΔEEffective = (ΔEE1 × Trade1 + ΔEE2 × Trade2 + … + ΔEEN × TradeN) / EEffective.
- The effective exchange rate can be calculated using different baskets of foreign currencies.
Exchange Rate Examples
- The value of the U.S. dollar depreciated by 35% against a basket of 7 major currencies from 2002 to 2008.
- The value of the U.S. dollar depreciated by 25% against a broad basket of 26 currencies from 2002 to 2008.
- The dollar was floating against major currencies but was fixed or tightly managed against other currencies, such as those of China and other Asian economies.
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Description
This quiz is about Ecuador's adoption of the US dollar as its official currency in 2000, a process known as dollarization. Test your knowledge on this economic phenomenon.
