1. Effects of Exchange Rate Changes
In the fall of 2004 the dollar was depreciating against the euro. Jean-Claude Trichet, the president of the
European Central Bank (the ECB), decried the depreciation of the dollar as "brutal" and "unwelcome."
Explain why Europeans felt threatened by the decline in the dollar. How do you think Trichet's comments
affected the value of the dollar at the time?
b. The dollar is currently appreciating against the euro and other currencies. How might this affect the US
2. The Old Model I
Consider the following short article about Argentina.
Suppose that the "domestic" currency is the Argentinian peso, while the "foreign currency" is the US
dollar. Use the Old Model to depict the determination of an initial exchange rate (pesos per dollar).
The first and second paragraphs of the article describe how the Argentinian peso depreciated after President
Macri announced a request for a loan from the IMF to cover his budget deficit. Use the Old Model to depict
how this announcement affect the value of the peso. [Hint: How were speculators responding to the news
that Argentina needed to borrow from the IMF? How did this affect the demand and supply of foreign
Depict how raising Argentinian interest rates (to 60 percent!) would offset the depreciation in part "b."
3. The Old Model II
Consider the traditional model of exchange rate determination developed in class. The home country is the
"domestic" country, and the exchange rate is the price of foreign currency. Initially, the exchange rate is
flexible. As depicted in the following graph, the exchange market is initially in equilibrium at an exchange rate
of E1. Now suppose that the U.S. imposes a tariff on imports of foreign goods and services.
a. What will happen to our imports? To the trade balance?
b. What will happen to the demand for foreign exchange? Depict this on the graph.
c. What will happen to the value of the dollar?
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