2010 Macro FRQ #3
(A) How will the transaction above affect Argentina's aggregate demand?
Argentina's imports will increase, therefore aggregate demand will decrease.
(B) Assume the US current account balance with Argentina is initially zero. How will the transaction above affect the US current account balance? Explain.
Balance of Payments Cheat Sheet here.
The US account balance will be a surplus as the US will have exported goods to Argentina. We will have a surplus in out current account and a deficit in the financial or capital account.
(C) Using a CLG of the FOREX market for the US dollar. show how a decrease in the US financial investment in Argentina affects each of the following.
(i) The supply of US dollars.
(ii) The value of the US dollar relative to the Peso.
Understand, that if the Argentinians are buying US goods they must go to the FOREX to buy US dollars as US suppliers do not accept Argentinian Pesos. So as Argentinians dump their money into the FOREX to buy US dollars the supply of US dollars in the FOREX decreases.
Obviously, when there is less of something the value of it increases. The value of the US dollar increases relative to the Peso.
(D) Suppose the inflation rate in the US is 3% and 5% in Argentina. What will happen to the value of the Peso relative to the US dollar as a result of the inflation rate difference? Explain.
Careful here as the college board is asking about the inflation rate (Price Level) not the interest rate as they do for so many of these problems.
If the US price level (inflation rate) is less than Argentinas then the prices of US goods are increasing at a slower rate than Argentinas goods. So relatively, US goods are going to be cheaper than the Argentinian goods.
If US goods are cheaper than the Argentinian goods, relatively. Then Argentinians are going to purchase (import) more US goods. Again, they have to buy US dollars to purchase US goods. As they do this the supply of Argentinian Pesos increase in the FOREX market. A larger supply means that the Argentinian peso will loose value against the US dollar.