Question

QUESTION 11 (10 minutes) LO7c) Foreign Exchange 4 MARKS a) Explain the relationship between an exchange rate appreciation and the Current Account; b) Explain the relationship between an exchange rate depreciation and Monetary Policy stance. 2 marks per question part. Note: keep explanations brief. Assume ceteris paribus for each situation.

Could you please help me to answer these questions with clear writing or typing! Thank you very much!

Answer 1

a. An appreciation of exchange rate makes the exports of the country expensive and imports cheaper, thus net exports which is given by the difference between total exports and total imports will fall. Trade account of the country which computes the difference between total exports of goods and services and total imports of goods and services, will fall. Thus, trade balance of the country will fall with appreciation of exchange rate and thus current account balance which consists of trade balance of the nation will fall.

b. An exchange rate depreciation makes the exports of the nation cheaper and increases the price of imports. Thus, net exports of the country will rise. This rise in the net exports will increase overall level of aggregate demand in the country and also increase inflation rate in the country. To control the level of inflation in the economy, the Fed will reduce the level of money supplied and thus follow tight monetary policy by either increasing reserve requirement ratio, selling government securities in the open market etc.