ECONOMICS: Principles and Applications 3e HALL & LIEBERMAN © 2005 Thomson Business and Professional Publishing Exchange Rates and Macroeconomic Policy

Table 1 Foreign Exchange Rates, August 8, 2003

The Demand for Pounds Curve Price of pounds British goods cheaper to Americans Americans buy more British goods Quantity of pounds demanded

Figure 1a The Demand for British Pounds (a) Dollars per Pound Millions of British Pounds E D£D£ A $ A drop in the price of the pound moves us rightward along demand for pounds curve

Figure 1b The Demand for British Pounds Dollars per Pound Millions of British Pounds The demand for pounds curve shifts rightward when: U.S. real GDP ↑ U.S. relative price level ↑ U.S. tastes shift toward British goods U.S. interest rate ↓ Pound is expected to appreciate (b)

The Supply of Pounds Curve Price of pounds U.S. goods goods cheaper to British Quantity of pounds supplied British buy more U.S. goods British need more dollars

Figure 2a The Supply of British Pounds (a) $ Dollars per Pound Millions of British Pounds E S£S£ F A rise in the price of the pound moves us rightward along supply of pounds curve

Figure 2b The Supply of British Pounds Dollars per Pound Millions of British Pounds The supply of pounds curve shifts rightward if: British real GDP↑ U.S. relative price level↓ British tastes shift toward U.S. goods U.S. interest rate↑ Pound is expected to depreciate (b)

Figure 3 The Equilibrium Exchange Rate Dollars per Pound Millions of British Pounds E S£S£ 300 $1.50 D£D£ S£S£ E C 300 $ Equilibrium in the market for pounds Higher U.S. real GDP leads to a higher price per pound Dollars per Pound Millions of British Pounds

Figure 4 Hypothetical Exchange Rate Data Over Time Dollars per Unit of Foreign Currency Years B E A C

Figure 5 Hot Money in the Very Short Run Dollars per Pound Millions of British Pounds per Month G E Q2Q2 $ Q1Q1

Figure 6 Exchange Rates in the Short Run 1.50 $1.80 B (a)(b) A 1.50 $1.80 B C Dollars per Pound Millions of British Pounds per month Dollars per Pound Millions of British Pounds per month S£S£

Figure 7a A Fixed Exchange Rate for the Baht (a) Millions of Baht per Month Dollars per Baht S baht Excess Demand D baht $ In both panels, Thailand fixes the exchange rate at $.04 per baht. 2.Here the supply and demand curves show the equilibrium exchange rate is $.06 per baht. 3.Thai Central Bank must sell 300 million baht to keep the baht from appreciating.

Figure 7 A Fixed Exchange Rate for the Baht S baht Excess Supply (b) D baht $ With these supply and demand curves, the equilibrium exchange rate is $.02 per baht. 5.Thai Central Bank must buy 300 million baht to keep the baht from depreciating Millions of Baht per Month Dollars per Baht

Figure 8 A Foreign Currency Crisis Millions of Baht per Month Dollars per Baht 400 $ A B

Exchange Rates and Monetary Policy Money supply Interest rate a and I P Real GDP U.S. assets less attractive Decreased supply and increased demand for foreign currency Dollar depreciates Net exports Net Effect: GDP  by more when exchange rate’s effect on net exports is included

Figure 9 Net Financial Flows into the United States as a Percent of GDP Net Financial Inflow (Percent of GDP) -1.0% 0.0% 1.0% 2.0% 3.0% 4.0%

Figure 10 How a U.S. Financial Inflow Creates a U.S. Trade Deficit Dollars per Yen Billions of Yen per Year B A 12,000 $ ,000 D¥D¥ 15,000 C Increase in Japan's exports to U.S. Japanese purchases of U.S. Assets Decrease in Japan's imports to U.S.

Figure 11 The Growing U.S. Trade Deficit with China Source: Wayne M. Morrison, “China-U.S. Trade Issues,” Congressional Research Service, Library of Congress, Updated May 16, U.S. exports to China U.S. imports from China U.S. trade deficit with China $ Billions Year

Figure 12 How an Undervalued Chinese Yuan Can Create a U.S. Trade Deficit Dollars per Yuan Billions of Yuan per Year B A 700 $ D YUAN S YUAN 1,000 C Decrease in China's imports from U.S. Increase in China's exports to U.S. Equilibrium value of Yuan Fixed value of Yuan