2019 Macro Set 2, FRQ #2, FOREX

2019 Macro FRQ #2 Set 2

 a) Current account balance is zero or balanced therefore (exports = imports)
If real US income increases then we could assume that imports will increase. Think about this from the perspective that a society that is wealthier will tend toward importing more goods from other countries. If imports > Exports then we have a current account deficit.

b) Understanding that as real income increases, imports increase. US citizens are importing more goods from the EU and therefore the EU is exporting more goods to the US. US citizens therefore dump US$ into the Forex demanding and buying Euros. Value of the € increases as demand for the € increases.

(i) If the interest rate is increasing in the EU then US citizens will buy Euros and deposit them into EU banks to get the higher rate of interest. The US will have a capital outflow as currency leaves the US and is a capital inflow into the EU. As US citizens dump their $ into the FOREX the demand for the US$ decreases and the value of the US$ decreases.