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Suggested answers to end of chapter questions and problems
1. In a clean oat, the government allows the exchange-rate value of its
currency to be determined solely by private (or nonocial) supply and
2. We often use the term pegged exchange rate to refer to a fixed exchange rate, because
fixed rates generally are not fixed forever. An adjustable peg is an exchange rate policy in
3. The disequilibrium is the di#erence between private demand for
foreign currency and private supply of foreign currency at the %xed
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
4. Disagree. If a country is expected to impose exchange controls, which usually make it
more difficult to move funds out of the country in the future, investors are likely to try to
5. The exchange controls are intended to restrain the excess private
demand for foreign currency (the source of the downward pressure on
the exchange-rate value of the country’s currency). Thus, some people
who want to obtain foreign currency, and who would be willing to pay
more than the current exchange rate, do not get to buy the foreign
6. a. The market is attempting to depreciate the pnut (appreciate the dollar) toward a value of
3.5 pnuts per dollar, which is outside of the top of the allowable band (3.06 pnuts per
b. In order to defend the pegged exchange rate, the Pugelovian government could impose
exchange controls in which some private individuals who want to sell pnuts and buy
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
c. In order to defend the pegged exchange rate, the Pugelovian government could increase
domestic interest rates (perhaps by a lot). The higher domestic interest rates shift the
incentives for international capital flows toward investments in Pugelovian bonds. The
7. a. Nonocial supply and demand are pressuring the dirham to appreciate
above the central bank’s informal target value. The Moroccan
b. For this situation in the foreign exchange market to be a temporary
disequilibrium, the Moroccan monetary authority expects that
c. If private investors and speculators believe that this is fundamental
disequilibrium, then they expect that the monetary authority will need
to continue to intervene, selling dirhams and buying dollars. The
private investors and speculators may believe that the Moroccan
monetary authority will not or cannot continue to intervene in this way
8. a. Let’s use the exchange rates as quoted (Danish krone per euro). The nonofficial demand
for euros (Deuro) and the nonofficial supply of euros (Seuro) intersect at point A,
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
A
Deuro
euros
Qd Qs
corresponding to an exchange rate of 7.1 krone per euro. This value is below the bottom
of the band around the central fixed rate of 7.46 per euro (the bottom band rate is about
7.29, equal to 7.46 minus 0.0225 times 7.46).
b. Nonofficial or private demand and supply is pressuring the exchange rate to fall below
the bottom of the band. The Danish central bank must intervene to defend the fixed
c. The Danish money supply will tend to increase. In the foreign exchange intervention, the
Danish central bank buys euros and sells Danish krone. Theintervention addsnewly
9. a. The implied %xed exchange rate is about $4.87/pound (or
20.67/4.2474).
b. You would engage in triangular arbitrage. If you start with dollars, you
buy pounds using the foreign exchange market (because as quoted the
pound is cheap). You then use gold to convert these pounds back into
159
© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
c. Buying pounds in the foreign exchange market tends to increase the
pound’s exchange-rate value, so the exchange rate tends to rise above
$4.00/pound (and toward $4.87/pound).
10. a. The gold standard was a fixed rate system. The government of each country participating
in the system agreed to buy or sell gold in exchange for its own currency at a fixed price
b. Britain was central to the system, because the British economy was the leader in
industrialization and world trade, and because Britain was considered financially secure
and prudent. Britain was able and willing to run payments deficits that permitted many
c. During the height of the gold standard, from about 1870 to 1914, the economic shocks to
d. Speculation was generally stabilizing, both for the exchange rates between the currencies
11. Key features of the interwar currency experience were that exchange
rates were highly variable, especially during the %rst years after World
War I and during the early 1930s. Speculation seemed to add to the
instability, and governments sometimes appeared to manipulate the
160
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
12. a. The Bretton Woods system was an adjustable pegged exchange rate system. Countries
committed to set and defend fixed exchange rates, financing temporary payments
b. The United States was central to the system. As the Bretton Woods system evolved, it
became essentially a gold-exchange standard. The monetary authorities of other countries
c. To a large extent speculation was stabilizing, both for the fixed rates followed by most
countries, and for the exchange rate value of the Canadian dollar, which floated during
1950-62. However, the pegged exchange rate values of currencies sometimes did come
under speculative pressure. International investors and speculators sometimes believed
that they had a one-way speculative bet against currencies that were considered to be "in
13. The Bretton Woods system of %xed exchange rates collapsed largely
because of problems with the key currency of the system, the U.S. dollar.
The dollar’s problems arose partly as a result of the design of the system
and partly as a result of U.S. government policies. As the system
evolved, it became a gold-exchange standard in which other countries
%xed their currencies to the U.S. dollar, largely held U.S. dollars as their
ocial reserve assets, and intervened to defend the %xed exchange
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
14. a. The dollar bloc and the euro bloc. A number of countries peg their currencies to the U.S.
dollar. A number of European countries use the euro, and, in addition, a number of other
countries peg their currencies to the euro.
b. Other major currencies that float independently include (as of 2014) the Japanese yen, the
British pound, and the Canadian dollar.
c. The exchange rates between the U.S. dollar and the other major currencies have been
floating since the early 1970s. The movements in these rates exhibit trends in the long run
—over the entire period since the early 1970s. The rates also show substantial variability
or volatility in the short and medium runs—periods of less than one year to periods of
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
