Question

Last year Nicaragua held elections. A very controversial political figure was elected president. There is uncertainty and anxiety among international investors. Illustrate the likely effect of this event on Nicaragua’s currency, the Cordoba. Is it likely to appreciate or depreciate?

Answer 1

A controversial political environment can lead to political instability, and investors will lower their investment in a politically unstable country. As international investment in Nicaragua decreases, demand for its domestic currency (Cordoba) decreases. In foreign exchange market, demand curve for Cordoba shifts left, lowering both exchange rate and quantity of Cordoba trade. Cordoba will depreciate.

In following graph, exchange rate (e) and quantity of Cordoba (Q) are measured vertically and horizontally respectively. D0 and S0 are initial demand and supply of Cordoba, intersecting at point A with initial exchange rate e0 and quantity of Cordoba Q0. As demand falls, D0 shifts left to D1, intersecting S0 at point B with lwoer interest rate e1 and lower quantity of Cordoba Q1.