For each of the following possible events, indicate whether the demand or supply curve for dollars would shift, the direction of the shift, the determinant of the change, the inflow or outflow effect on the balance of payments (and the specific account that would be affected), and the resulting movement of the equilibrium exchange rate for the value of the dollar. (a) American cars become suddenly more popular abroad. (b) Inflation rates in the United States accelerate. (c) The United States falls into a depression. (d) Interest rates in the United States drop. (e) The United States suddenly experiences rapid increases in productivity. ( f ) Anticipating a return to the gold standard, Americans suddenly rush to buy gold from the two big producers, South Africa and the Soviet Union. (g) War is declared in the Middle East. (h) The stock markets in the United States suddenly collapse.
Fall, rise, fall, rise
To analyze each event, we need to consider the impact on the demand or supply curve for dollars, the direction of the shift, the determinant of the change, the balance of payments effect, and the resulting movement of the equilibrium exchange rate.
(a) American cars become suddenly more popular abroad:
- Demand curve for dollars would shift to the right.
- The determinant of the change is an increase in demand for American cars.
- This leads to an inflow effect on the balance of payments, specifically on the current account (exports of goods).
- The higher demand for dollars would lead to an appreciation of the dollar in the equilibrium exchange rate.
(b) Inflation rates in the United States accelerate:
- Supply curve for dollars would shift to the right.
- The determinant of the change is increased inflation rates.
- This could lead to an outflow effect on the balance of payments, particularly on the capital account (capital flight).
- The increased supply of dollars could lead to a depreciation of the dollar in the equilibrium exchange rate.
(c) The United States falls into a depression:
- Demand curve for dollars would shift to the left.
- The determinant of the change is a decrease in economic activity.
- This would likely lead to an outflow effect on the balance of payments, especially on the current account (imports of goods).
- The reduced demand for dollars could lead to a depreciation of the dollar in the equilibrium exchange rate.
(d) Interest rates in the United States drop:
- Demand curve for dollars would shift to the right.
- The determinant of the change is reduced interest rates.
- This could lead to an inflow effect on the balance of payments, particularly on the capital account (foreign investment).
- The increased demand for dollars could lead to an appreciation of the dollar in the equilibrium exchange rate.
(e) The United States suddenly experiences rapid increases in productivity:
- Demand curve for dollars would shift to the right.
- The determinant of the change is increased productivity.
- This would likely lead to an inflow effect on the balance of payments, specifically on the current account (exports of goods).
- The higher demand for dollars could lead to an appreciation of the dollar in the equilibrium exchange rate.
(f) Anticipating a return to the gold standard, Americans suddenly rush to buy gold from the two big producers, South Africa and the Soviet Union:
- Demand curve for dollars would shift to the right.
- The determinant of the change is increased demand for gold.
- This could lead to an outflow effect on the balance of payments, particularly on the current account (imports of goods).
- The increased demand for dollars could lead to an appreciation of the dollar in the equilibrium exchange rate.
(g) War is declared in the Middle East:
- Supply curve for dollars would shift to the right.
- The determinant of the change is geopolitical uncertainty.
- This would likely lead to an outflow effect on the balance of payments, especially on the capital account (capital flight, decreased foreign investment).
- The increased supply of dollars could lead to a depreciation of the dollar in the equilibrium exchange rate.
(h) The stock markets in the United States suddenly collapse:
- Demand curve for dollars would shift to the left.
- The determinant of the change is decreased investor confidence.
- This could lead to an outflow effect on the balance of payments, particularly on the capital account (capital flight).
- The reduced demand for dollars could lead to a depreciation of the dollar in the equilibrium exchange rate.
Please note that these are general explanations, and in real-world scenarios, the impact on the exchange rate may be influenced by various factors. Additionally, other events not mentioned here could also affect the exchange rate.