Foreign exchange market diagram
Question: 3) Draw a supply-demand diagram of the foreign exchange market for the dollar (valued in euros/$).
3) Draw a supply-demand diagram of the foreign exchange market for the dollar (valued in euros/$) Show the effects of the following events on the exchange rate. Explain your reasoning!
a) The release of data showing stronger than expected RGDP growth in Germany.
b) An increase in the federal funds rate by the Federal Reserve
c) An announcement that U.S. trade deficits for the last quarter were much larger than previously expected
d) A larger than expected increase in hourly wage rates in the US.
4) If the Fed wished to defend the exchange rate of the $ (i.e. prevent the $ exchange rate from falling) what policy action could it take? Explain.
5a) What is the "purchasing power parity" theory of exchange rates? If the price of a representative bundle of tradable goods is currently $5000 in the U.S. and 550000 yen in Japan, is the $ undervalued or overvalued when the exchange rate is 90 yen per $?
5b) Why don't actual exchange rates move to purchasing power parity levels in the short run?
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