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Unit 28 — Exchange Rates

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Purpose:

To show the effect of exchange rates on trade and domestic growth and inflation, and the effect of domestic economic events on foreign exchange rates.

Objectives:

  1. If the value of the dollar compared to other currencies increases, goods exported from the U.S. will cost more in terms of foreign currencies than before, and imports will cost less than before. Therefore, net exports will tend to fall, depressing economic growth in the U.S. and stimulating growth overseas.
  2. A country’s ability to import and export changes over time because of underlying changes in relative wage rates, productivity, technology, etc. When such long-term changes occur, either the exchange rates have to be realigned or the country which has lost its competitive ability will have to endure a long period of slow growth in order to restore the trade balance.
  3. The following will tend to cause the dollar to fall vis-à-vis foreign currencies:

    1. a higher real growth rate in the U.S. (because it will cause net exports to fall);
    2. a higher inflation rate in the U.S. (because people will want to hold currencies that are not depreciating);
    3. a lower interest rate in the U.S. (because people will convert their dollars to foreign currencies to earn high interest);
    4. pessimism regarding the relative value of investment opportunities in the U.S. The converse of these effects will cause the dollar to rise.
  4. While flexible exchange rates are more volatile than fixed exchange rates, they tend to create fewer distortions and macroeconomic challenges.

Audio and Transcripts

Meet the Series Experts

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Eduard M. Bernstein

Eduard M. Bernstein

Principal Economist for the U.S. Treasury, 1940–1946, during which time he also served as Assistant Director of the Monetary Research Division and Assistant to the Secretary of the U.S. Treasury Department.

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Joan Spero

Joan Spero

Under Secretary of State for Foreign and Agricultural Affairs, under President Bill Clinton, and United States Ambassador to the United Nations Economic and Social Council, 1980–1981.

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Marina Von Neuman Whitman

Marina Von Neuman Whitman

Professor of Business Administration and Public Policy at the University of Michigan since 1992, and Senior Staff Economist to the Council of Economic Advisers, 1970–1971.

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ECONOMICS IQ?

  1. All of the following factors contributed significantly to the chronic deficit in our balance of payments during the 1960s and 1970s EXCEPT:

    increased foreign demand for American exports.

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  2. If the exchange rate of dollars to francs is $0.14, then the exchange rate of francs to dollars is:

    7:1

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  3. Suppose that a number of French consumers decide to purchase shares of stock on the New York Stock Exchange. In that case, the exchange rate (in terms of dollars to the franc) will:

    chart chart

    fall because of greater supply.

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  4. This diagram shows that under fixed exchange rates, Germany has a:

    chart chart

    balance of payments deficit and its currency is overvalued.

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  5. The MAIN reason that President Roosevelt went off the gold standard was that:

    he believed that a devalued dollar might rekindle a failing economy.

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  6. The MAIN criticism most economists of today would probably make of the Bretton Woods agreement is that it:

    was inherently inflexible, and thus not adaptable to changing economic conditions.

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Glossary

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Key Terms