Question

The United States’ major trading partner is Canada. Ceteris paribus, explain what will happen (and why it will happen) to the value of the U.S. dollar if each of the following events occur:

A. Canada reduces tariffs on goods imported from the U.S.

B. The U.S. decreases its money supply.

C. The U.S. reduces taxes and increases government spending.

D. Canadian residents choose to buy goods produced in Canada instead of goods produced in the U.S.

Answer 1

a)

It will cause appreciation of US dollar.

Reduction in tariff will increase export of US and now more foreign exchange would be earned. Hence, currency appreciates on huge influx of foreign exchange.

b)

It will again appreciate US dollar.

Drop in money supply increases interest rate in market. Rise in interest rate attracts investments from elsewhere. Thus, money enters into US market. It would cause appreciation of dollar.

c)

Fall in taxes and increase in government spending would cause rise in aggregate demand. Rise in aggregate demand further increases import. thus dollar will outflow thereby reducing value of dollar.

Value of dollar will depreciate.

d)

Value of dollar will depreciate.

Fall in demand for US export would reduce earning of US companies. Hence, dollar will depreciate due to fall in earning of foreign exchange.