6. a unit of domestic currency can buy more units
of foreign currencies
Depreciation
a unit of domestic currency can buy less units of
foreign currencies
7. demand for X
capital inflow
people expect domestic currency appreciate
demand for domestic currency
appreciation of domestic currency
17. Depreciation will improve the balance of payments
position of a country, provided that the sum of
elasticities of foreign demand for domestic exports
( Ex) domestic demand for imports ( Em )is
greater than one.
19. Depreciation (effect on exports)
export prices in foreign currency
(Au$1 Au$0.96)
(export prices in domestic currency
unchanged)
(HK$5 HK$5)
Qd of X
export value ( P x Q) in domestic currency
(HK$5 x 1000 HK$5x 1200)
21. Depreciation
import prices in domestic currency
(HK$5 HK$5.2)
(import prices in foreign currency unchanged)
(Au$1 Au$1)
Qd of M
value of imports ( P x Q) in domestic currency ?
23. If demand for exports is elastic ( Ex > 1)
export value ( P x Q) in domestic currency
If demand for imports is elastic ( Em > 1)
import value in domestic currency
24. Therefore, if demand for exports and demand
for imports are elastic, depreciation of domestic
currency will lead to improvement of balance of
payments situation.
If Ex + Em > 1
depreciation will lead to improvement of BOP
25.
26. the official exchange rate is altered so that a unit
of the domestic currency can buy fewer units of
foreign currencies
Revaluation
the official exchange rate is altered so that a unit
of the domestic currency can buy more units of
foreign currencies
27. The gap between official exchange rate and
equilibrium exchange rate will be reduced.
Exports become more competitive in the
international market.
Imports become more expensive.
30. The gap between official exchange rate and
equilibrium exchange rate will be reduced.
Exports become less competitive in the
international market.
Imports become cheaper.
41. D”
exchange rate
Q
amount of foreign currency
HK$5
Au$1
HK$
Au$
fixed rate
S
Bop surplus
D’
government increase the
demand for foreign
currency
42. exchange rate
Q
amount of foreign currency
HK$7.8
US$1
HK$
US$
S
D
upper limit
lower limit
Dirty Floating
43. prohibit or restrict the purchase of foreign
exchange
black market will emerge
44. BOP deficit to support the
exchange rate, govt
S of foreign currency
( D for domestic currency)
Ms P
X , M
BOP deficit
(if Marshall-Lerner
Condition is
satisfied???
interest rate
capital inflow
45. Ms in foreign country
P in foreign currency
trade surplus (X , M )
to maintain the fixed exchange rate,
government demand for foreign currency
(supply of domestic currency )
Ms P
46. r in foreign country
capital inflow in domestic country
to maintain the fixed exchange rate,
government demand for foreign currency
(supply of domestic currency )
Ms r
48. Flexible exchange rate
exchange rate is
determined by
demand for and
supply of foreign
currency
Fixed exchange rate
the government fixes
the foreign exchange
rate by buying and
selling of foreign
exchange
49. Flexible exchange rate
depreciation or
appreciation of a
currency is determined
by the market forces
speculation in foreign
exchange market is
common
Fixed exchange rate
devaluation or
revaluation of a
currency is determined
by the government
speculation occurs
when there is rumour
about the change in
government policy
50. Flexible exchange
rate
self-adjusting
mechanism
operates to
eliminate external
disequilibrium by
change in foreign
exchange rate
Fixed exchange rate
self-adjusting
mechanism
operates through
the change in
money supply,
domestic interest
rate and domestic
price
51. a currency will not be over-valued or under-valued
Balance of payments deficit or surplus will be
corrected automatically through market forces
lead to an efficient allocation of resources
no “policy conflict”
enables a country to pursue an independent
economic policy
52. minimize outside influences on the domestic
economy as there is no imported inflation or
deflation
there is no need for central banks to keep official
reserves in order to intervene in the foreign
exchange market
53. Flexible Exchange Rate
increase business
uncertainties and reduce
volume of trade
Such uncertainties can
be reduced or eliminated
by forward market
Fixed Exchange Rate
there are also
uncertainties under
the fixed exchange
rate system
speculative
transactions are self-
fulfilling
54. Flexible Exchange
Rate
increase currency
speculation and it is
therefore destabilizing
speculation can be
stabilizing
Fixed Exchange Rate
one-way option
speculation
55. Flexible Exchange
Rate
The external sector
is always in
equilibrium
no “policy problem”
Fixed Exchange Rate
Inflation in a country will
lead to balance of
payment deficits and the
government is likely to
initiate contractionary
policies to combat
inflation.
“deflationary biased”
56. inflation in domestic country
BOP deficit
supply of foreign currency
government initiates contrationary policies to
combat inflation
57. if BOP deficit + unemployment
What should the government do?
contrationary policy (e.g. G ), or
expansionary policy (e.g. G )
59. This system was adopted at a time following rapid
depreciation of the Hong Kong dollar. It was used
by the Hong Kong government to stabilize the
value of the Hong Kong dollar.
60. the authorities are not obliged to intervene, as
there is an ‘arbitrage and competition’ mechanism
to ensure the convergence of the market rate with
the official rate.
65. If there are no transaction costs, arbitrage in either
direction will continue until the free market
exchange rate equals the linked rate.
If there are transaction costs, the free- market
exchange rate will fluctuate within a narrow range
around the linked exchange rate.
66. The note-issuing banks can only issue currency
notes by paying US dollars to the Exchange Fund
in advance.
currency in Hong Kong cannot be increased if
Hong Kong is unable to earn US dollars, or other
foreign currencies easily convertible into US
dollars
67. inflation in HK
X , M
BOP deficit
note-issuing banks’ demand
for HK$
Ms
69. AL 89/9
Under the fixed exchange rate system, a
country can correct its balance of payments
deficit by either devaluing its currency or
implementing a contractionary domestic
policy.
a. Explain with appropriate diagrams how
the two policies can reduce a balance of
payments deficit.
b. 'These two policies have different impacts
on the economy and, as a result, should be
used under different conditions.' Explain.
73. AL 90/7
Under Hong Kong's present linked exchange
rate system, what will happen to the
exchange rate between the Japanese yen
and the Hong Kong dollar, if assuming other
things being equal,
a. the US dollar depreciates by 10 percent
against the Japanese yen?
b. Hong Kong has a large surplus against
Japan in its balance of payments?
c. the inflation rate rises in the U.S.A.?
Use simple diagrams to illustrate your answer.
77. AL 94/6
Use demand and supply analysis, with the
vertical axis as the exchange rate (price of
foreign currency) to explain how an increase
in imports would affect
a. the exchange rate under a floating exchange
rate system.
b. the official and the black market exchange
rates in a fixed exchange rate system
(assume that the black market exchange
rate is initially higher than the official rate).
80. 96/8
Under a fixed exchange rate system Country A
over-values its currency, which leads to an
external deficit.
a. Illustrate the situation using a well-labelled
diagram.
b. What should be the government of
Country A do in the foreign exchange market
to maintain the exchange rate at the fixed
rate? How will this affect the money supply of
Country A?
c. Explain whether Country A can eliminate
its external deficit by promoting export
