Chapter 18
ANSWERS TO QUESTIONS
1. You are considering buying a bottle of wine. Suppose that the euro appreciates by 15% with
respect to the U.S. dollar. Are you more or less likely to buy a bottle of Californian wine or
French wine?
Assuming that you are buying the Californian wine from the U.S and the French wine from
2. “A country is always worse off when its currency is weak (falls in value).” Is this statement
true, false, or uncertain? Explain your answer.
False. Although a weak currency has the negative effect of making it more expensive to buy
foreign goods or to travel abroad, it may help domestic industry. Domestic goods become
3. When the U.S. dollar depreciates, what happens to exports and imports in the United States?
U.S. dollar depreciation makes U.S. domestic goods cheaper, thus both domestic and foreign
4. If the Japanese price level rises by 5% relative to the price level in the United States, what
does the theory of purchasing power parity predict will happen to the value of the Japanese
yen in terms of dollars?
It predicts that the value of the yen will fall 5% in terms of dollars.
5. If the demand for a country’s exports falls at the same time that tariffs on imports are raised,
will the country’s currency tend to appreciate or depreciate in the long run?
In the long run, the fall in the demand for a country’s exports leads to a depreciation of its
6. When the Federal Reserve conducts an expansionary monetary policy, what happens to the
money supply? How does this affect the supply of dollar assets?
7. From 2009 to 2011, the economies of Australia and Switzerland suffered relatively mild
effects from the global financial crisis. At the same time, many countries in the euro area
were hit hard by high unemployment and burdened with unsustainably high government
debts. How should this have affected the euro/Swiss franc and euro/Australian dollar
exchange rates?
This would reduce the demand for euro-denominated assets, resulting in a depreciation of the
euro and an appreciation of the Swiss franc and Australian dollar.
8. In the mid- to late 1970s, the yen appreciated in value relative to the dollar, even though
Japan’s inflation rate was higher than America’s. How can this be explained by
improvements in the productivity of Japanese industry relative to American industry?
Even though the Japanese price level rose relative to the American, the yen appreciated
9. Suppose the president of the United States announces a new set of reforms that includes a new
anti-inflation program. Assuming the announcement is believed by the public, what will happen
to the exchange rate on the U.S. dollar?
The dollar will appreciate. Because expected U.S. inflation falls as a result of the
10. If the British central bank lowers interest rates to reduce unemployment, what will happen to
the value of the pound in the short run and in the long run?
The pound depreciates, declining in both the short run and the long run. Consider Britain to
be the domestic country. The lower domestic interest rate on pound assets lowers the
11. If the Indian government unexpectedly announces that it will be imposing higher tariffs on
foreign goods one year from now, what will happen to the value of the Indian rupee today?
The Indian rupee will appreciate. The announcement of tariffs will raise the expected future
12. If nominal interest rates in America rise but real interest rates fall, predict what will happen
to the U.S. dollar exchange rate.
The dollar will depreciate. A rise in nominal interest rates but a decline in the real rate implies
13. If American auto companies make a breakthrough in automobile technology and are able to
produce a car that gets 200 miles to the gallon, what will happen to the U.S. dollar exchange
rate?
The dollar will appreciate. The increase in U.S. productivity raises the expected future
14. If Mexicans go on a spending spree and buy twice as much French perfume and twice as
many Japanese TVs, English sweaters, Swiss watches, and bottles of Italian wine, what will
happen to the value of the Mexican peso?
The peso will depreciate. Consider Mexico to be the domestic country. An increased demand
15. Through the summer and fall of 2008, as the global financial crisis began to take hold,
international financial institutions and sovereign wealth funds significantly increased their
purchases of U.S. Treasury securities as a safe haven investment. How should this have
affected U.S. dollar exchange rates?
This should (and did) lead to a sharp appreciation of the dollar relative to many other
16. On June 23, 2016, voters in the United Kingdom voted to leave the European Union. From
June 16 to June 23, 2016, the exchange rate between the British pound and the dollar
increased from 1.41 dollars per pound to 1.48 dollars per pound. What can you say about
market expectations regarding the result of the referendum?
As noted in the text, a vote to leave the European Union would lower future U.K. Exports and
thus lead to a lower long-run value of the British pound. The fact that the British pound rose
ANSWERS TO APPLIED PROBLEMS
17. A German sports car is selling for €65,000. What is the dollar price in the United States for
the German car if the exchange rate is 0.80 euro per dollar?
€65,000 × ($1/0.80 euros) = $81,250.
18. If the Canadian dollar to U.S. dollar exchange rate is 1.24 and the British pound to U.S.
dollar exchange rate is 0.68, what must be the Canadian dollar to British pound exchange
rate?
19. The New Zealand dollar to U.S. dollar exchange rate is 1.38, and the British pound to U.S.
dollar exchange rate is 0.65. If you find that the British pound to New Zealand dollar is
trading at 0.5, what would be the riskless profit per U.S. dollar invested?
Complete the following transactions simultaneously:
i. Exchange $1.00 into 1.38 New Zealand dollars.
20. In 1999, the euro was trading at $0.90 per euro. If the euro is now trading at $1.18 per euro,
what is the percentage change in the euro’s value? Is this an appreciation or depreciation?
% Change = (1.18 – 0.90)/0.90 = 31.11%. The euro has appreciated by 31.11%.
21. The Mexican peso is trading at 11 pesos per dollar. If the expected U.S. inflation rate is 1%
while the expected Mexican inflation rate is 15% over the next year, given PPP, what is the
expected exchange rate in one year?
Expected exchange rate = 11 × (1.15/1.01) = 12.525 pesos per dollar.
22. If the price level recently increased by 19% in England while falling by 6% in the Canada, by
how much must the exchange rate change if PPP holds? Assume that the current exchange
rate is 0.58 pound per dollar.
If prices rise relative to Canada by (19 + 6)% = 25%, then 25% more pounds will be required
23. If the European Central Bank decides to pursue a contractionary monetary policy to fight
inflation, what will happen to the value of the U.S. dollar?
The dollar will depreciate. The drop of expected inflation in Europe, which leads to a decline
in the foreign interest rate (which is smaller than the drop in expected inflation), leads to a
24. If a strike takes place in France, making it harder to buy French goods, what will happen to
the value of the U.S. dollar?
The contractionary policy will increase European interest rates and raise the future value
Consider France to be the domestic country. Because it is harder to get French goods, people
will buy more foreign goods and the value of the euro in the future will fall. The expected
ANSWERS TO DATA ANALYSIS PROBLEMS
1. Go to the St. Louis Federal Reserve FRED database and find data on the exchange rate of
U.S. dollars per British pound (DEXUSUK). A Mini Cooper can be purchased in London,
England, for £17,865 or in Boston, United States, for $23,495.
a. Use the most recent exchange rate available to calculate the real exchange rate of the
London Mini per Boston Mini.
According to the exchange rate for July 28, 2017, the real exchange rate is $1.3124/£
b. Based on your answer to part (a), are Mini Coopers relatively more expensive in Boston
or in London?
Since you can buy 1.002 minis in London for every one purchased in Boston, they are
slightly relatively less expensive in London.
c. What price in British pounds would make the Mini Cooper equally expensive in both
locations, all else being equal?
If the real exchange rate equaled 1, this would imply 1 Boston mini/London mini =
2. Go to the St. Louis Federal Reserve FRED database and find data on the daily dollar
exchange rates for the euro (DEXUSEU), British pound (DEXUSUK), and Japanese yen
(DEXJPUS). Also find data on the daily three-month London Interbank Offer Rate, or
LIBOR, for the United States dollar (USD3M-TD156N), euro (EUR3MTD156N), British
pound (GBP3MTD156N), and Japanese yen ( JPY3M-TD156N). LIBOR is a measure of
interest rates denominated in each country’s respective currency.
USD LIBOR
EUR LIBOR
GBP LIBOR
JPY LIBOR
25-Jul-17
1.31667
−0.37286
0.28681
−0.00807
25-Jul-16
0.73350
−0.30357
0.52350
−0.03343
USD-EUR LIBOR
USD – GBP
LIBOR
USD – JPY
LIBOR
1.68953
1.02986
1.03707
0.21000
USD per GBP
a. Calculate the difference between the LIBOR rate in the United States and the LIBOR
rates in the three other countries using the data from one year ago and the most recent
data available.
See table above.
c. Report the percentage change in the exchange rates over the past year. Are the results
you predicted in part (b) consistent with the actual exchange rate behavior?