Exchange rates: Practice Questions

Which of the following is most likely to cause an appreciation of a country’s currency under a floating exchange rate system?

Which combination of effects is most likely to occur in the domestic economy following a significant depreciation of the national currency?

The table below shows the exchange rate indices for Country X against its two main trading partners, Partner A and Partner B, and their respective shares in Country X's total trade.

Partner A (Share: \( 60\% \)): Index moves from 100 to 110
Partner B (Share: \( 40\% \)): Index moves from 100 to 90

What is the resulting change in the trade-weighted exchange rate index for Country X?

How is an increase in a country's domestic interest rates expected to affect its exchange rate, assuming all other factors remain constant?

In a managed float exchange rate system, what is the typical role of the central bank?

Define a floating exchange rate and state how an increase in a country's interest rates is likely to affect the external value of its currency.

Explain the J-curve effect and why a devaluation only improves the trade balance after time has passed, assuming the Marshall-Lerner condition \( |PED_x| + |PED_m| > 1 \) is eventually satisfied.

(a) Explain the distinction between a devaluation of a currency and a depreciation of a currency.

(b) Using the J-curve diagram as a reference, analyze why the current account of the balance of payments might initially move further into deficit immediately following a devaluation before eventually improving.

(c) The Marshall-Lerner condition states that a devaluation will only improve the balance of trade if the sum of the price elasticities of demand for exports and imports is greater than 1: \( |PED_x| + |PED_m| > 1 \). Evaluate the extent to which the success of a devaluation depends on these elasticities and discuss other factors that might limit its effectiveness.