Welker’s Wikinomics practice activities
3.2 Exchange Rates
The Determinants of Exchange Rates
Part 1 - Floating Exchange Rates
1. Add labels to the axes in the graphs below. Use Google to find the current exchange
rates for Swiss francs (chf) in the US and the US$ in Switzerland. Add these values as
the equilibrium exchange rates in your graphs.
The actual exchange rates on your graphs will depend on the values at the time you completed
this activity. Something like the charts below are correct. (Switch CHF for Euros)
2. The Swiss National Bank engages in an expansionary monetary policy to stimulate
domestic demand. Explain and show the effects this policy will have on the markets for
the Swiss francs in the US and the US$ in Switzerland.
Diagram on left (market for CHF in US) should show a decrease in D.
Diagram on right (market for USD in Switzerland) should show a decrease in S.
Explain:
As a results of the SNB’s expansionary monetary policy demand for CHF will decrease among
Americans and the supply of US$ in Switzerland will decrease, causing the CHF to depreciate
and the US$ to appreciate. This occurs because lower interest rates in Switzerland will make
investments in Swiss assets less attractive to American investor (lower returns on savings and
bonds).
3. Explain the most likely effect of the SNB’s policy on Switzerland’s net exports,
consumption and investment.
On one hand (likely more short term), domestic inflation (due to AD growth in I & C)
may reduce demand for Swiss exports.
On the other hand (likely more long term) the depreciation of the CHF will likely lead to
an increase in Swiss exports (due to exchange rates—prices of Swiss goods relatively
become cheaper).
1
Welker’s Wikinomics practice activities
4. New scenario: There is widespread speculation that the US$ will depreciate against
other foreign currencies. Starting with today’s exchange rate as equilibrium, illustrate the
effect speculation will have on two markets below.
Diagram on left (market for CHF in US) should show a decrease in S.
Diagram on right (market for USD in Switzerland) should show a decrease in D.
5. Explain the impact the speculation described in #4 will most likely have on the level of
aggregate demand and aggregate supply in the US?
Speculation of a depreciation of the US$ will lead international investors to demand
less US$ today and supply fewer CHF. This will cause the US$ to depreciate, which
should boost US net exports and increase AD. However, AS should decrease
because of higher resource prices from abroad.
6. How should each of the following variables affect the value of each currency relative to
the other? Assume ceteris paribus for each scenario.
a. Switzerland experiences disinflation while inflation in the US accelerates.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of relative inflation
b. Switzerland’s GDP growth rate increases while the US economy stagnates
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of changes in income. Wealthier Swiss will want more US
imports.
c. Remittances from Americans working in Switzerland increase to an all-time high.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Americans earning CHF must convert their earnings into US$ to send
their incomes back into the US. This will cause the demand for US$ to
increase and supply of CHF to increase, causing the US$ to appreciate
d. US investors purchase stocks from Swiss firms.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of investment from abroad
e. Major labor strikes in Switzerland result in a sudden increase in the price of
French goods.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of relative inflation rates
f. The Federal Reserve raises interest rates in the US.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of relative interest rates
2
Welker’s Wikinomics practice activities
g. The US government spends more money on its national defense.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of relative interest rates (government spending increased,
causing US interest rates to increase)
h. The US government puts a quota on products from Switzerland that can be
imported into the US
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of US demand for Swiss imports decreasing
i. US citizens start traveling to Switzerland in large amounts.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of increased need for US citizens to acquire Swiss Francs (not
one of the IB-specified determinants)
j. Swiss companies begin importing tremendous amounts of US steel.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of Swiss demand for US imports
k. Swiss companies sell their plants in the US, moving their factories to another
country.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of changes in FDI (Foreign Direct Investment). Swiss
companies need less USD now
l. Because of uncertainty in the US, people anticipate the Swiss stock market to do
better.
i.
Value of the USD: APPRECIATE OR DEPRECIATE? (Circle one)
ii.
Value of the CHF: APPRECIATE OR DEPRECIATE?
iii.
Because of changes in portfolio investment from abroad
3