ECN220 Global Economy and Exchange Rates

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Questions and Answers

What was one aim of Nixon's temporary 10% tariff on imports?

To eliminate trade deficits

To reduce domestic inflation

To encourage foreign countries to devalue their currencies

To push other countries to revalue their currencies (correct)

What change was made to the official gold price during the Smithsonian Agreement?

It was raised to $38 per ounce (correct)

It remained unchanged

It was raised to $40 per ounce

It was lowered to $36 per ounce

What characterized the post-1973 international monetary system?

A purely market-driven exchange system

Complete reliance on gold standards

A managed floating regime (correct)

A fixed exchange rate system

Why do governments intervene in floating exchange rate systems?

To manage fluctuations during excessive volatility Signup and view all the answers

How has Japan attempted to maintain its international price competitiveness?

By purchasing large amounts of dollars Signup and view all the answers

What primarily drives non-Canadians' demand for Canadian dollars (CAD$)?

To purchase Canadian exports and assets Signup and view all the answers

What happens to the quantity supplied of Canadian dollars (CAD$) as the exchange rate rises?

It increases Signup and view all the answers

What is one reason for supplying Canadian dollars?

To pay for imports and acquire assets Signup and view all the answers

What occurs when there is a surplus of Canadian dollars (CAD$)?

The quantity supplied exceeds the demand Signup and view all the answers

How is the supply of one currency related to the demand for another currency?

Supply of one currency is demand for another Signup and view all the answers

What is the reciprocal exchange rate for one Canadian dollar (CAD$) to U.S. dollar (USD)?

1.3755 USD Signup and view all the answers

In the context of currency speculation, why would someone demand Canadian dollars?

To hedge against the weakening of U.S. dollar Signup and view all the answers

What does a shortage of Canadian dollars indicate?

The demand for CAD$ exceeds its supply Signup and view all the answers

What is the function of the U.S. dollar in foreign exchange transactions between non-dollar currencies?

It often acts as an intermediary or vehicle currency. Signup and view all the answers

In the context of the foreign exchange market, what role does the interbank market serve?

It provides real-time information on foreign exchange conditions. Signup and view all the answers

If the U.S. dollar appreciates from an exchange rate of 1.375 to 1.60 CAD, how does this affect the price of a product initially priced at $1,000 USD in Canada?

The price in Canada increases to $1,600 CAD. Signup and view all the answers

What is a characteristic of a floating exchange-rate system?

It is determined by market forces without government intervention. Signup and view all the answers

How does the law of demand influence the quantity demanded for Canadian dollars as the exchange rate rises?

The quantity demanded decreases. Signup and view all the answers

What happens when a Canadian bank buys a large amount of yen from a Japanese firm?

It can sell the yen immediately to avoid holding it. Signup and view all the answers

What entails a 'vehicle currency' in the foreign exchange market?

A currency used for international trade between other currencies. Signup and view all the answers

What is the main purpose of the spot foreign exchange market?

To facilitate real-time currency conversion for immediate transactions. Signup and view all the answers

What does it mean when the CAD$ is said to be overvalued at CAD$1 = US$1?

The value of the Canadian dollar exceeds its purchasing power. Signup and view all the answers

Which economic principle explains the relationship between the price of a Big Mac in the U.S. and Canada?

Purchasing Power Parity (PPP) Signup and view all the answers

What is a key disadvantage of a fixed exchange rate system?

It requires large reserves of foreign currency. Signup and view all the answers

What happens to the supply and demand for CAD$ when the Canadian dollar is overvalued?

Americans will reduce their demand for CAD$. Signup and view all the answers

How does a fixed exchange rate provide stability for a country's trade?

It reduces uncertainties associated with currency value. Signup and view all the answers

What intervention occurs when the exchange rate hits the upper or lower limit of a fixed band?

The central bank may buy or sell foreign currency. Signup and view all the answers

What effect does an overvalued CAD$ have on Canadian consumers compared to their American counterparts?

They can purchase fewer goods in the U.S. Signup and view all the answers

Which of the following is a primary aim of maintaining a fixed exchange rate?

To provide stability for international trade. Signup and view all the answers

What was a primary factor that contributed to Britain's decision to tie the pound to gold?

Favorable gold-silver value ratios Signup and view all the answers

What was a result of Britain's gold parity decision in 1925?

High unemployment and loss of price competitiveness Signup and view all the answers

How did gold movements during the gold standard period influence national economies?

By impacting money supply, inflation, and macroeconomic stability Signup and view all the answers

Which event initiated the currency crisis during the Great Depression?

Collapse of Austria's Creditanstalt Signup and view all the answers

What characterized the economic policies of the 1930s that worsened the global depression?

Adoption of beggar-thy-neighbor policies Signup and view all the answers

Which of the following statements is true regarding the Bretton Woods System established in 1944?

The U.S. emerged as a leader due to its gold reserves and economic power. Signup and view all the answers

What led to the hyperinflation in Germany between 1922 and 1923?

Massive devaluation of the German mark Signup and view all the answers

What was a common consequence of countries abandoning the gold standard in the early 1930s?

Use of tariffs and trade restrictions for job protection Signup and view all the answers

What was a key feature of the Bretton Woods system concerning exchange rates?

Adjustable peg allowing for changes under fundamental disequilibrium Signup and view all the answers

Which plan proposed the establishment of a central institution to offer reserves to deficit countries?

White’s Plan Signup and view all the answers

What event in 1971 effectively ended the gold-dollar link under the Bretton Woods system?

Suspension of dollar convertibility to gold by Nixon Signup and view all the answers

What was one primary outcome of the U.S. payment deficits during the Bretton Woods era?

Accumulation of U.S. dollars in foreign reserves Signup and view all the answers

Which item highlights a reason for the Dollar Crisis in the 1960s?

Emergence of competitive economies in Europe and Japan Signup and view all the answers

Which principle did Keynes’s Plan advocate for to ensure balanced international payments?

Automatic adjustments for surpluses and deficits Signup and view all the answers

What was the official price of gold per ounce under the Bretton Woods system?

$35 Signup and view all the answers

What solution did the U.S. choose instead of shrinking the economy to reduce deficits?

Changing international system rules Signup and view all the answers

Study Notes

ECN220 Evolution of the Global Economy

This course examines the evolution of the global economy.

Foreign Exchange Rates

Different countries use their own currencies.
Exchange rates convert one currency's value into another.
Foreign exchange is the trading of currencies between nations. This mirrors how money is used within a country.
October 2024 exchange rates are detailed in a table.

Types of Exchange Rates

Spot Exchange Rate: Used for immediate currency exchanges.
- For large trades, delivery usually occurs two business days after the agreement.
- Some currency pairs (e.g., USD and CAD) result in delivery within one business day.
Forward Exchange Rate: Agreed upon today for a future currency exchange (e.g., 30, 90, or 180 days).
- Used to lock in exchange prices for future transactions.

Foreign Exchange Market

A decentralized system, not a single physical location.
Banks are key dealers.
Most transactions involve banks in London and New York.
Most transactions pair the US dollar with other currencies.
The US dollar often acts as an intermediary in non-US dollar currency exchanges.
This widespread use of the US dollar makes it a "vehicle currency."

Spot Foreign Exchange Market

Facilitates smooth payment flows between individuals, businesses, and organizations with different currencies.
Enables transactions for a wide range of activities including trade in goods and services and foreign financial assets as captured in the balance of payments.

Interbank Market

Plays a crucial role in providing banks real-time foreign exchange rates and conditions.
Observing quoted exchange rates allows banks to interact with other traders.
Enables quick and cost-effective adjustments to financial positions after large trades.
- A Canadian bank, buying yen from a Japanese firm, may quickly sell the yen to another bank.

Appreciation and Depreciation

Exchange rates influence the cost of products in different countries.
For example, a product priced at 1,000USDintheUS,wouldbeequivalentto1,000 USD in the US, would be equivalent to 1,000USDintheUS,wouldbeequivalentto1,375 Canadian dollars at an exchange rate of 1.375 USD/CAD. If the USD/CAD rate were to rise to 1.60, then the same product would cost $1,600 Canadian dollars.

Demand and Supply for Foreign Exchange

Supply of one currency is the demand for another currency.
In a floating exchange rate system, the foreign exchange rate is determined by market forces (demand and supply).

Demand in Foreign Exchange

The law of demand for Canadian dollars means a rise in exchange rates results in decreased demand for CAD$.
Non-Canadians' demand for CAD$ depends on Canadian goods, exports, assets, and speculation on future value.

Supply in Foreign Exchange

The law of supply for Canadian dollars dictates a rise in exchange rates results in increased supply of CADS.
Reasons for supply of CADs include paying for imports and speculative activity on future CADS values.

Equilibrium in Foreign Exchange Market

The supply and demand for CADs cross at a specific price, resulting in an equilibrium rate.
This determines the price of CADs in relation to other currencies.

Reciprocal Exchange Rate

Divide 1 by the other exchange rate.
When CADappreciatesagainstanycurrency,thatcurrencydepreciatesagainstCAD appreciates against any currency, that currency depreciates against CADappreciatesagainstanycurrency,thatcurrencydepreciatesagainstCAD.

Floating Exchange Rates

Exchange rate fluctuations result from shifts in interest rates, inflation rates, Canadian real GDP, global demand for exports, and speculator expectations.
These factors impact both demand and supply curves in the foreign exchange market.

Increase in Canadian Interest Rate Differential

When Canadian interest rates rise, Canadian assets become more attractive to investors.
This leads to increased demand for CAD,thusincreasingCAD, thus increasing CAD,thusincreasingCAD value. Increased demand and a limited supply causes the Canadian dollar to appreciate.

Decrease in Canadian Interest Rate Differential

Conversely, falling Canadian interest rates make Canadian assets less attractive.
This leads to lower demand for CAD$, causing Canadian dollar depreciation.

Inflation Rate Differential

A rise in Canadian inflation rate compared to another country influences the supply and demand for CAD$.
As goods/services become more expensive in Canada, the supply of CAD rises (so it must be sold for greater value in other currencies) and demand of CAD falls.

Canadian Real GDP

Rising GDP increases the demand for CADs as Canadian assets become attractive.
Higher demand drives an appreciation of CADs against other currencies. Alternatively, a decline in GDP would drive depreciation.

Globalization Transmission Mechanisms

Exchange rates affect a country's real GDP and inflation rate through the globalization transmission mechanism, especially impacting net exports, aggregate demand, and the price level.
A depreciating Canadian dollar boosts net exports and drives the economy into expansion, while a rising dollar yields the opposite effect.

Purchasing Power Parity (PPP)

The law of one price, purchasing power parity, and rate of return parity are standards used to estimate future exchange rates.
PPP allows money to have the same purchasing power in different countries.
For example, if a book costs 8intheU.S.andCAD8 in the U.S. and CAD8intheU.S.andCAD10 in Canada, then CAD$ per USD is 0.80.

Fixed Exchange Rates

Currency value is pegged to another major currency (e.g., US dollar, or a basket of currencies).
This value is maintained by government or central bank intervention, even if it varies from a market equilibrium.
Pegged rates can fluctuate within a prescribed trading band.

Gold Standard

Each country pegged its currency to a specific quantity of gold.
This led to stable exchange rates.
This system was widely regarded as successful and stabilized systems worldwide.

Bretton Woods System

The system reflected the U.S.'s strong economic position.
It featured a fixed exchange rate system.
Automatic adjustments for surpluses and deficits were part of policies.

Dollar Crisis

Issues involving the U.S. dollar's role as a reserve currency led to the collapse of the Bretton Woods System.
Large U.S. payment deficits worsened the issue.
A significant drop in U.S. gold reserves made the system less sustainable.

Current International Monetary System

A managed floating exchange rate system.
Most countries peg their currencies to one another.
Governments may intervene in the market.

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Description

This quiz explores the evolution of the global economy, focusing on foreign exchange rates and types of exchanges such as spot and forward rates. It helps students understand the role of currencies in international trade and the foreign exchange market.