Assuming that exchange rates are determined by the market, what would be the eff
ID: 2624333 • Letter: A
Question
Assuming that exchange rates are determined by the market, what would be the effect of the following scenarios on the exchange rate between the Brazilian real and the U.S. dollar (expressed in terms of reais per dollar)? Circle one option (rise vs. fall vs. remains unchanged) and provide a brief explanation - i.e.. 1-2 phrases or sentences. (H s: 1) note the precise question here: it asks about the exchange rate defined in terms of reais per dollar: more reais per dollar = a fall in the value of the real relative to the dollar, and vice versa; 2) in each case: assume all other conditions are unchanged) There is a drought in Brazil which leads to the failure of sugar and citrus crops, both of which are major exports to the U.S. The U.S. expands its steel industry and starts increasing its imports of iron ore from Brazil (one of the largest producers of iron ore in the world). There is a recession in the U.S. Brazil's labor productivity increases, while U.S. labor productivity remains unchanged. Brazil experiences a higher inflation rate than the U.S. Brazil experiences the same inflation rate as the U.S. Protesters in Brazil, due to high inflation threaten a coup: with widespread expectations of political instability. Brazil tightens its monetary policy (h : this increases theinterest rate in Brazil) The U.S. imposes an import quota on Brazilian sugar due to lobbying from domestic U.S. sugar producers. An import substitution industrialization policy in Brazil is followed to protect domestic producers. Imports from all countries are discouraged, including the U.S.Explanation / Answer
a) Fall. Exports will bring USD into the country and Real will appreciate. So failure of exports means that Real will fall wrt USD
b) Rise. Imports of iron ore from Brazil implies more USD billing, hence Real will appreciate.
c) Fall. Recession in US means lesser trade between Brazil and US. Brazil is net exporter to the US so exports will fall and hence the currency
d) Rise. An increase in labour productivity means that cost of production and hence landed cost in other countries is lesser. In US labour productivity is the same so they will be willing to pay the same price. So demand from exports from Brazil to US will increase and hence Real will appreciate.
e) Fall. Higher inflation means weaker currency. In terms of exports landed cost will remain same bu the value in Real will he higher. Hence Real should be weaker than USD in the case.
f) Unchanged. With all other conditions the same, FX rate will remain unchanged.
g) Fall. Political instability and other threats will lead to significant weakening of the domestic currency.
h) Rise. With higher interest rates, money supply reduces and hence domestic currency will appreciate.
i) Fall. Restricing exports from Brazil will lead to a fall in Real.
j) Rise. When imports into Brazil are resticted, there is less outgo of Real, which will lead to Real appreciation