Help with HSC MC Please :) (1 Viewer)

sy37

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I go with D. This is the why:

At equilibrium, the price is determined by supply and demand factors (market). If a country is experiencing a boom, as is in answer D, then it would have increased demand for its currency and will hence drive the price of the currency up and cause an appreciation. The problem with an appreciation is that the country will experience a decrease in international competitiveness because foreign consumers find it less attractive to import their products so that country will then experience decreased export revenue, and hence reduced terms of trade --> Increasing CAD etc. So, an appreciation during a boom is bad. However on a fixed exchange rate system you can, like what China has done before, fix the currency below its equilibrium exchange rate. This will solve the aforementioned problems etc.

When we talk of exchange rates, we mainly look at the impacts on importers / exporters unless otherwise stated.
 

Mikes

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I go with D. This is the why:

At equilibrium, the price is determined by supply and demand factors (market). If a country is experiencing a boom, as is in answer D, then it would have increased demand for its currency and will hence drive the price of the currency up and cause an appreciation. The problem with an appreciation is that the country will experience a decrease in international competitiveness because foreign consumers find it less attractive to import their products so that country will then experience decreased export revenue, and hence reduced terms of trade --> Increasing CAD etc. So, an appreciation during a boom is bad. However on a fixed exchange rate system you can, like what China has done before, fix the currency below its equilibrium exchange rate. This will solve the aforementioned problems etc.

When we talk of exchange rates, we mainly look at the impacts on importers / exporters unless otherwise stated.
I guess it depends on how you interpret the question. I wouldn't have chosen D because if a country fixes its exchange rate below the equilibrium rate, then it will lead to a decrease in the purchasing power of that country's currency. This is adverse during a boom as there is often high levels of inflation due to demand pull factors; if the currency depreciates during this time, this would a) increase the country's international competitiveness and hence increase the volume of exports and b) make it less attractive for domestic consumers to seek alternatives from oversea markets, thus contributing to inflation again. Both of these outcomes is unfavourable, leading to excessive inflation which is unsustainable. However, there is also your argument (regarding the CAD), which is valid as well.

I think A would be more appropriate as during a recession a country would benefit from having a lower exchange rate. This would increase the country's international competitiveness, stimulating aggregate demand (X) and economic growth through exports. With option A, there isn't the problem of a CAD because exports will (only) increase while imports will decrease and, since Australia's service obligations are denominated in AUD, the valuation effect will not affect the primary incomes account.
 
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Ekman

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I go with D. This is the why:

At equilibrium, the price is determined by supply and demand factors (market). If a country is experiencing a boom, as is in answer D, then it would have increased demand for its currency and will hence drive the price of the currency up and cause an appreciation. The problem with an appreciation is that the country will experience a decrease in international competitiveness because foreign consumers find it less attractive to import their products so that country will then experience decreased export revenue, and hence reduced terms of trade --> Increasing CAD etc. So, an appreciation during a boom is bad. However on a fixed exchange rate system you can, like what China has done before, fix the currency below its equilibrium exchange rate. This will solve the aforementioned problems etc.

When we talk of exchange rates, we mainly look at the impacts on importers / exporters unless otherwise stated.
That could be said for answer B as well. As the currency for a country experiencing a boom is usually appreciated, whereas a country experiencing a recession has a depreciated currency. So the answer is identical with D then.

I would of went with A for the reasons Mikes said above
 

turnerloos

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I go with D. This is the why:

At equilibrium, the price is determined by supply and demand factors (market). If a country is experiencing a boom, as is in answer D, then it would have increased demand for its currency and will hence drive the price of the currency up and cause an appreciation. The problem with an appreciation is that the country will experience a decrease in international competitiveness because foreign consumers find it less attractive to import their products so that country will then experience decreased export revenue, and hence reduced terms of trade --> Increasing CAD etc. So, an appreciation during a boom is bad. However on a fixed exchange rate system you can, like what China has done before, fix the currency below its equilibrium exchange rate. This will solve the aforementioned problems etc.

When we talk of exchange rates, we mainly look at the impacts on importers / exporters unless otherwise stated.
https://www.tafensw.edu.au/courses/g...w/how-to-enrol
You should definitely reconsider.
 

atargainz

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Yep Mikes knows whats up. I would go for A, a country with low interest rates will tend to have a lower exchange rate (less demand for dollar), and a lower exchange rate contributes to international competitiveness and therefore growth which is beneficial for an economy undergoing a recession.
 

matchalolz

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Board of studies really fucked up with this question, there are actually two answers: A and D.
I really appreciate all the answers, although I'm confused with sy37's a bit because, you said that when a country is booming it will appreciate the exchange rate but I thought that higher growth leads to greater import consumption because of higher disposable incomes?? hence increased demand for foreign currencies

I think there is still a logic behind option D but I'm really bad at this hahaha
thanks guys!

EDIT: NEVERMIND i see why you said so i think: higher growth = central bank boots up interest rates to curb inflation-> appreciation kk
 
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sy37

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I guess it depends on how you interpret the question. I wouldn't have chosen D because if a country fixes its exchange rate below the equilibrium rate, then it will lead to a decrease in the purchasing power of that country's currency. This is adverse during a boom as there is often high levels of inflation due to demand pull factors; if the currency depreciates during this time, this would a) increase the country's international competitiveness and hence increase the volume of exports and b) make it less attractive for domestic consumers to seek alternatives from oversea markets, thus contributing to inflation again. Both of these outcomes is unfavourable, leading to excessive inflation which is unsustainable. However, there is also your argument (regarding the CAD), which is valid as well.

I think A would be more appropriate as during a recession a country would benefit from having a lower exchange rate. This would increase the country's international competitiveness, stimulating aggregate demand (X) and economic growth through exports. With option A, there isn't the problem of a CAD because exports will (only) increase while imports will decrease and, since Australia's service obligations are denominated in AUD, the valuation effect will not affect the primary incomes account.
Right, I checked to see which was right and both A and D would have been right for that particular case, which I think is odd. It's a bad question and both have valid arguments, but I'm still hesitant to go with A only because of the wording of the question. Here's why

The reason I did not choose A (B,C were obviously eliminated) is because during a recession aggregate demand would have be low and by extension, inflationary pressures as well --> this would increase international competitiveness through more exports etc. If a country used this as an argument for fixing its exchange rate, I argue that it's not necessary because during a recession inflationary pressures are already low and exports will begin rising by the cyclical nature of the business cycle, this to me is a given and you don't need a fixed exchange rate to overcome this.

In D, during a boom aggregate demand would be high as well as inflation. Increasing inflation erodes your international competitiveness, and by fixing your exchange rate to a lower value you'll obviously be able to maintain or increase current export volumes. You cannot increase volumes of exports during high inflationary pressures.

The key difference is that during a boom where inflationary pressures are high, a country cannot experience an increase in export volumes - as is in D. However, during a recession, a country can experience an increase in international competitiveness because a decrease in aggregate demand, by extension, will reduce inflationary pressures and thus increase exports.

Think of it this way, a country doesn't need a fixed exchange rate to experience an increase in export volumes during a recession. Conversely, a country does need a fixed exchange rate to experience an increase in export volumes during a boom.

Then because of the above, I would definitely pick D over A. I could see the argument made for A if extra additional information was provided by the question, but unless I'm misunderstanding something I don't think it is the best for the above reasons and I'm happy to be corrected otherwise.
 
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sy37

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Board of studies really fucked up with this question, there are actually two answers: A and D.
I really appreciate all the answers, although I'm confused with sy37's a bit because, you said that when a country is booming it will appreciate the exchange rate but I thought that higher growth leads to greater import consumption because of higher disposable incomes?? hence increased demand for foreign currencies

I think there is still a logic behind option D but I'm really bad at this hahaha
thanks guys!

EDIT: NEVERMIND i see why you said so i think: higher growth = central bank boots up interest rates to curb inflation-> appreciation kk
Referring to your edit, that is right and does contribute to an appreciation but is not the main factor from my understanding atleast. During a boom a country experiences an increase in export volume --> There is now increased demand from foreign importers for the $AUD since they need to convert their foreign currency to $AU --> By the law of supply and demand the market will respond to this increase in demand of the $AU and diminishing supply of the $AU by increasing the value of the $AUD --> An appreciation will result
 
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Can someone explain why option B and D is different.

In reality, wouldn't B also depreciate the value of the currency, allowing for increased export competitiveness?
 

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