A. The US trade deficit has worsened. As a result speculators are selling dollars.

Show the likely

impact of this on the US dollar exchange rate with the euro in the diagram below.

B. The US government has raised interest rates. As a result overseas demand for US currency
deposits has increased. Show the likely impact of this on the US dollar exchange rate with the
euro in the diagram below.

C. Each month German food processors import 100 tons of pistachio nuts from Iran. The export
price of each ton of pistachio nuts is 40,000 Iranian rials.
i) What is the total cost in euros of 100 tons of pistachio nuts at an exchange rate of €1 = 10
rials?
ii) What will happen to the total import costs of the German producers if the euro depreciates
against the Rial to €1 = 8 rials? [5]
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D. FIIL IN THE GAP

When firms import goods and services they must also use___________________
to pay the country they bought them from. The price of a foreign currency is
known as its foreign___________________. That is, its value in terms of other
countries’___________________. Most currencies are allowed to
__________________ on the foreign exchange market according to the demand
and___________________ of each currency. When the value of a currency falls it
is known as __________________ of its value. A rise in the price of a currency is
known as an___________________. Some governments have intervened in the
foreign exchange market to fix their own value for their currency. This is known
as___________________ exchange rate. Sometimes due to changing international
markets the governments have to lower the exchange rate which is known
as___________________. Governments all control the price of its currency by
selling or buying of their currency which is termed as___________________.
 Government Intervention in the
exchange rate
Fixed Exchange Rate
A fixed exchange rate system refers to the case where the exchange rate is set and maintained at same level
by the government irrespective of the market forces.
The diagram below shows a fixed exchange rate

REVALUATION AND DEVALUATION

It refers to official changes in the price of a currency in a fixed exchange rate system.

 Devaluation is when the price of the currency is officially decreased in a fixed exchange rate system.
 Revaluation is the official increase in the price of the currency within a fixed exchange rate system.

Managed Exchange Rate

A managed exchange rate occurs when there is official intervention by a government or an agency such as the
Central Bank to determination the value of a country’s exchange rate. Through such official interventions it is
possible to manage both fixed and floating exchange rates.
For example,
The Fedral Bank may decide to enter the foreign exchange market as either a buyer or seller to stabilise any
short-term fluctuation in the value US$. To limit a fall in the value of US$ (depreciation) the Fed will buy US$,
and to prevent a rise in the value of US$, the central bank will sell US$ in the market.
Such intervention by the central bank is known as a “dirty float”, or more correctly a “managed float”.
Other Government actions and their effect
Expansionary monetary policy (↑MS) causes an increase in GNP and a depreciation of the domestic currency
in a floating exchange rate system in the short run.
Contractionary monetary policy (↓MS) causes a decrease in GNP and an appreciation of the domestic
currency in a floating exchange rate system in the short run.
Expansionary fiscal policy (↑G, ↑TR, or ↓T) causes an increase in GNP and an appreciation of the domestic
currency in a floating exchange rate system.
Contractionary fiscal policy (↓G, ↓TR, or ↑T) causes a decrease in GNP and a depreciation of the domestic
currency in a floating exchange rate system.
In the long run, once inflation effects are included, expansionary monetary policy (↑MS) in a full employment
economy causes no long-term change in GNP and a depreciation of the domestic currency in a floating
exchange rate system. In the transition, the exchange rate overshoots its long-run target and GNP rises then
falls.
A sterilized foreign exchange intervention will have no effect on GNP or the exchange rate in the AA-DD
model, unless international investors adjust their expected future exchange rate in response.
A central bank can influence the exchange rate with direct Forex interventions (buying or selling domestic
currency in exchange for foreign currency). To sell foreign currency and buy domestic currency, the central
bank must have a stockpile of foreign currency reserves.
A central bank can also influence the exchange rate with indirect open market operations (buying or selling
domestic treasury bonds). These transactions work through money supply changes and their effect on interest
rates.
Purchases (sales) of foreign currency on the Forex will raise (lower) the domestic money supply and cause a
secondary indirect effect upon the exchange rate.

Appreciation, currencies, depreciation, devaluation, exchange rate, fixed, float

foreign currency, managed flexibility, supply.