Question

In each of the following scenarios, state whether the euro will be expected to appreciate or...

In each of the following scenarios, state whether the euro will be expected to appreciate or to depreciate in a system of floating exchange rates and briefly explain:

            i. a recession in Germany cuts German purchases of U.S. goods

            ii. American investors are attracted by prospects for profits on the Frankfort Stock Exchange

            iii. Real interest rates on government bonds rise in the U.S. but remain stable in Germany

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Answer #1

Answer:-

(i) As Germany lowers purchase from US (imports from the US), German demand for the US falls, which means that US dollar depreciates and correspondingly, euro appreciates.

(ii) Higher US investment in German stock exchange will increase the demand for euro, therefore euro will appreciate.

(iii) The higher relative interest rate in the US will make global investors invest more in the US, which will increase demand for US dollar, causing the dollar to appreciate. Accordingly, euro depreciates.

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