Assume that one year ago, the Canadian Dollar (CAD) was quoted at Australian Dollar (AUD) 0.82500 and that today the CAD is trading at AUD 0.8011. Assume that Canada and Australia are trading partners. Which of the following statements is least likely? Over the past year, the Canadian: A) economy ran a current account deficit. B) government recently undertook an unanticipated expansionary fiscal policy action. C) economy grew at a faster rate than the Australian economy. D) government undertook an unanticipated expansionary monetary policy action.
C??? I have yet to cover L2-Econ, but coming from L1-Econ, here’s what I think 1 year ago -> CAD/ AUD = 0.82500 Today -> CAD/ AUD = 0.8011 So AUD depreciated, means CAD appreciated No if we look at answer ‘C’ If Canadian Economy would have grown faster than Australian Economy, then the demand for imports from Australia in would have been high in Canada. So the need to sell off CAD and buy AUD would increase to cover the import-shocks. So CAD gets flooded at the FX and CAD should go DOWN. But our Exchange Rates prove that CAD went up over the last year, so ‘C’ seems to be the FALSE statement.
a
a- basically when a country run a current account deficit, there were more import than export. so there were less demand for domestic currency and more demand for the trade partner currency. hence domestic currency will depreciate. which is a false statement
I say D its not A because current acct deficit/surplus does not directly affect currency value unexpected expansionary monetary polilicy will decrease the real int rate thus make the investment in the country less attractive compared to other countries, which will decrease the value of the currency
Please correct me if I’m wrong, it’s pretty early here. In this context the forex quotes should be taken as .825 AUD / CND and .8011 AUD / CND. The CND depreciated, and the only answer that cannot explain this is B - unanticipated expansionary fiscal policy. With unanticipated fiscal policy expansion, the govt runs budget deficits and requires funding, driving rates up and causing foreign capital to flow into the country. While it is true that aggregate demand and imports increase, putting downward pressure on the home currency, interest rate effects dominate in the short-run. You can rule out answers A and C just by knowing that expansionary monetary policy and fiscal policy have opposite effects on the home currency.
Good call jblazarus… I think that is something we all screwed up in our responses B must be correct
Good job Jblazarus. Your answer: C was incorrect. The correct answer was B) government recently undertook an unanticipated expansionary fiscal policy action. From the given exchange rates, we determine that the Canadian Dollar has depreciated against the Australian Dollar (the CAD now buys less units of AUD). An unanticipated shift to a more expansionary fiscal policy will, in the short run, (and we are told that the policy change was recent) lead to appreciation. The increased aggregate demand results in higher economic growth and higher inflation. These two factors normally result in currency depreciation. However, the third impact of the policy, increased budget deficits and government borrowing, increases real interest rates, resulting in currency appreciation. This last effect dominates in the short run. The other statements would most likely lead to currency depreciation (or demand for foreign currency). A current account deficit means that a country imports more than it exports. As a result, there is increased demand for foreign currency. An unanticipated shift to expansionary monetary policy would lead to currency depreciation. The expansionary policy leads to higher economic growth, an accelerated inflation rate (increased demand for foreign goods), and lower real interest rates (the country’s assets are less attractive to foreigners). All these factors cause a nation’s currency to deprecia
good question
I agree on B. Unanticipated expansionary fiscal policy action leads to higher interest rate. Currency will appreciate. So it is least likely here.