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Chapter 21: Q6. (page 451)

Suppose that the government of China is currently fixing the exchange rate between the US dollar and the Chinese yuan at a rate of \(1 = 6 yuan. Also, suppose that at this exchange rate, the people who want to convert dollars to yuan are asking to convert \)10 billion per day of dollars into yuan, while the people who want to convert yuan into dollars are asking to convert 36 billion yuan into dollars. What will happen to the size of China鈥檚 official reserves of dollars?

a. They will increase.

b. They will decrease.

c. They will stay the same.

Short Answer

Expert verified

The correct option is option (a): they will increase.

Step by step solution

01

Deterioration in FOREX reserves

The overall official reserves consist of various foreign currencies, collection of bonds issued by the government, gold reserves, and special reserves held at the IMF.The collection of only foreign currencies is called foreign-exchange reserves or FOREX reserves.

Any change in either of these constituents of the official reserve will change the amount of reserve held by the central bank.

02

Size of China’s official reserves

The fixed exchange rate between the US dollar and the Chinese yuan is $1=6. At this exchange rate, the number of dollars getting converted into yuan is $10 billion.

The amount of yuan the people want to convert into a dollar is 36 billion yuan.

The amount in dollars will be

36/6 = $6 billion

The outflow ($6) of foreign currency from the official reserve is less than the inflow ($10) of foreign currency into the official reserve.

Thus, the net effect on China鈥檚 official reserve will be that they will increase.

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Most popular questions from this chapter

Suppose that a country has a trade surplus of \(50 billion, a balance on the capital account of \)10 billion, and a balance on the current account of 鈭抃(200 billion. The balance on the capital and financial account is:

a. \)10 billion.

b. \(50 billion.

c. \)200 billion.

d. 鈭�$200 billion.

An American company wants to buy a television from a Chinese company. The Chinese company sells its TVs for 1,200 yuan each. The current exchange rate between the U.S. dollar and the Chinese yuan is \(1 = 6 yuan. How many dollars will the American company have to convert into yuan to pay for the television?

a. \)7,200

b. \(1,200

c. \)200

d. $100

Explain: 鈥淯.S. exports earn supplies of foreign currencies that Americans can use to finance imports.鈥� Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets:

a. A U.S. airline firm purchases several Airbus planes assembled in France.

b. A German automobile firm decides to build an assembly plant in South Carolina.

c. A U.S. college student decides to spend a year studying at the Sorbonne in Paris.

d. An Italian manufacturer ships machinery from one Italian port to another on a Liberian freighter.

e. The U.S. economy grows faster than the French economy.

f. A U.S. government bond held by a Spanish citizen matures, and the loan amount is paid back to that person.

g. It is widely expected that the Euro will depreciate in the near future.

Refer to the following table, in which Qd is the quantity of loonies demanded, P is the dollar price of loonies, Qs is the quantity of loonies supplied in year 1, and Qs鈥� is the quantity of loonies supplied in year 2. All quantities are in billions, and the dollar-loonie exchange rate is fully flexible.

QdPQsQ's
101253020
151202515
201152010
25110155

a. What is the equilibrium dollar price of loonies in year 1?

b. What is the equilibrium dollar price of loonies in year 2?

c. Did the loonie appreciate, or did it depreciate relative to the dollar between years 1 and 2?

d. Did the dollar appreciate or did it depreciate relative to the loonie between years 1 and 2?

e. Which one of the following could have caused the change in relative values of the dollar (used in the United States) and the loonie (used in Canada) between years 1 and 2: (1) More rapid inflation in the United States than in Canada, (2) an increase in the real interest rate in the United States but not in Canada, or (3) faster income growth in the United States than in Canada?

Suppose that the Fed is fixing the dollar-pound exchange rate at $2.50 = 拢1. If the Fed鈥檚 reserve of pounds falls by 拢500 million, by how much would the supply of dollars increase, all other things equal?
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