Chapter 10

Question 1

Exchange rate

Answer 1

price one currency exchanges for another currency
- exchange rate is the price of 1 CAD

Question 2

Foreign exchange market

Answer 2

worldwide market where currencies are bought and sold

Question 3

currency depreciation

Answer 3

fall in exchange rate of one currency for another

Question 4

currency appreciation

Answer 4

rise in exchange rate of one currency for another

Question 5

Law of demand for CAD

Answer 5

as exchange rate rises, quantity demanded for C$ decreases

Question 6

Law of supply for CAD

Answer 6

as exchange rate rises, quantity supplied of C$ increases

Question 6

Below equilibrium exchange rate

Answer 6

excess demand (shortages) for C$ buyers competition causes exchange rate to rise

Question 7

Above equilibrium exchange rate

Answer 7

excess supply (surpluses) for C$, sellers competition causes exchange rate to fall

Question 8

reciprocal exchange rate

Answer 8

divide 1 by the other exchange rate
- so that when C$ appreciates against any currency, that currency depreciates against C$ and vice versa

Question 9

interest rate differential

Answer 9

difference in interest rates between countries
- ex: increase in Canadian interest rate differential causes C$ to appreciate (increases demand and decreases supply of $C)

Question 10

inflation rate differential

Answer 10

difference in inflation rate between countries
- ex: increase in Canadian inflation rate differential causes C$ to depreciate (decreases demand and increases supply of C$)

Question 11

effects of increasing Canadian real GDP on C$

Answer 11

• increased investor confidence causes strong appreciation (big increase demand C$, decrease)
• increased imports cause small depreciation (small increase supply C$)
• net effect is C$ appreciates

Question 12

Solo changes in demand for C$

Answer 12

• increasing ROW demand for Canadian exports causes slight appreciation of C$ (increased demand for C$)
• rising world prices for Canadian resource exports cause C$ to appreciate relative to currencies of non-resource producing countries (increased demand for C$)

Question 13

International transmission mechanism

Answer 13

how exchange rates affect real GDP and inflation
- appreciating C$ is a negative AD shock

which decreases net exports:
- decreasing AD, real GDP
- increasing unemployment
- decreasing inflation
- pushes the economy into a contraction

Question 14

depreciating C$

Answer 14

is a positive AD shock… which increases net exports
- increasing AD, real GDP
- decreasing unemployment
- increasing inflation
- pushes the economy into expansion

Question 15

law of one price

Answer 15

profit seekers eliminate differences across markets in prices of the same product
- predictions where exchange rates settle based on the law of one price

Question 16

purchasing power parity (PPP)

Answer 16

exchange rates adjust so that money has equal real purchasing power in any country

if PPP does not hold:
- ppl sell C$ for US$ and the increased supply of CAD causes the canadian dollar to depreciate
- when PPP does not exist, profit seeking forces and law of one price push exchange rate toward PPP rate
- PPP does not account for trading limitations and the role of speculators influencing exchange rates

Question 17

rate of return parity (interest rate parity)

Answer 17

rates of return on investments are equal across countries, accounting for expected depreciation or appreciation of exchange rates

FORMULA: rate of return in country A= rate of return in country B - expected depreciation or appreciation of currency A against currency B

Question 18

floating exchange rate

Answer 18

determined by demand and supply in foreign exchange market

Question 19

fluid exchange rate

Answer 19

determined by government or central banks (earlier fold standard as fixed exchange rate) d

Question 20

balance of payment acounts

Answer 20

measure a country’s international transactions through
- current account
- financial capital account
- statistical discrepancy

Question 21

current account measures

Answer 21

flows from exports and imports
- canadian exports create positive inflow of C$
- imports create negative outflow of C$

Question 22

current account deficit (negative balance)

Answer 22

when canadian spending on imports from ROW is greater than ROW spending on canadian exports
- there is a financial capital account surplus with ROW loaning canada extra foreign policy through investments

Question 23

current account surplus (positive balance)

Answer 23

when ROW spending on canadian exports is greater than canadian spending on imports fromm ROW
- there is a financial capital account deficit

Question 24

financial capital account

Answer 24

measures international investments in financial assets like bonds and direct investment in buying companies

Question 25

financial account deficit (negative balance)

Answer 25

when canadian investments in ROW are greater than ROW investments in Canada

Question 26

financial account surplus (positive balance)

Answer 26

when ROW investments in canada are greater than canadian investments in ROW

Question 27

statistcal discrepancy

Answer 27

for missing data and errors is not important for balance of payment accounts