Question

Assume that two countries, Country A and Country B, have an equilibrium exchange rate of 4 "A dollars" = 1 "B dollars". Country B then begins to experience a relatively faster growth of income. Assuming a floating exchange rate, predict what will happen in the foreign exchange market between these two countries currencies - which will appreciate and which will depreciate? If on the other hand Country B wished to keep their exchange rate unchanged (fixed), what might they attempt to do?

Answer 1

In case Country B begins to experience a relatively faster growth of income , then assuming floating exchange rate , then Country B's currency will appreciate as compared to Country A's currency- which will depreciate. It will make importing costlier to Country A, whereas imports will become cheaper to Country B and vice versa for exports.

If on the other hand Country B wished to keep their exchange rate fixed, then the import and export will remain as it is, however the internal position of Country B will improve leading to overall improvement in standard of living, with more exports to other countries including Country A