Effects of Dollar Appreciation and Depreciation

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Date Submitted: 09/07/2011 09:21 PM

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a) Since it is known that the national income is a fixed amount and if the government increases it’s spending, its total spending increases the national income and thus bringing the excessive amount to equilibrium import is inevitable. One can therefore assume that it’s true that a trade deficit occur if the government spends more than it receives in tax revenue. This increase in import causes the trade deficit for the country.



If savings and investments are constant an increase in the government spending over taxation will lead to the increase in Import over export, bringing it to equilibrium and in turn leads to a trade deficit.

b) It is true that in an open, mixed economy, the equilibrium level of GDP occurs when planned saving equals planned investment. When saving is the only withdrawal and investment is the only injection then at that level the planned investment and the planned saving decides the equilibrium level for the GDP.



The figure above shows the point where savings intersects investment is the level of equilibrium for GDP.

c) It is true that an increase in interest rates in the rest of the world will lead to a stronger dollar. If we take the International fisher’s effect also known as the interest rate parity in consideration we can find that an increase in the interest rate of foreign countries will offset any opportunity of arbitrage by strengthening dollar. So for any country abroad an increase in the interest rate will lead to strengthening of the dollar value as compared to the currency of that country.

d) It is true that under a fixed exchange rate system with global capital flows, monetary policy is ineffective. With a fixed exchange rate an increase in money supply create a balance of payment deficit as the exchange rate doesn’t fall. At the same time the money supply also falls because Fed buy dollars with foreign exchange to eliminate the balance...