Posted by Gary.L on .
China is one of the few countries in the world to have a fixed exchange rate. In the past, it has experienced a huge increas in exports of goods. Use a "FOREX" diagram to show the effect of the increase in exports. In your answer you must explain the effect of the export surge on the money supply, the holdings of the Chinese Central Bank of gold and foreign exchange, the Current Account and Capital Account balances, and on China's overall Balance of Payments. For convenience you can assume that the Current Account is in deficit and the Capital Account is in surplus
I know the export increase will results in the large demand for Chinese currency, therefore in the demand-supply graph,the demand curve for chinese currency will shift rightwards, this should reduce the exchange rate, however the government use fixed exchange rate policy, so it requires the government to buy foreign currency or gold to satisfy this excess demand.
Overall the money supply of Chinese currency will increase, the GFE(CB) will increase. But how about the rest? the Current account and Capital Account balances? Why the question mention the 2 assumptions?