Econs Qn

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) economy grew at a faster rate than the Australian economy. C) government undertook an unanticipated expansionary monetary policy action. D) government recently undertook an unanticipated expansionary fiscal policy action.

so firstly work out which currency went up/down: one yr ago, 1 CAD got you 0.825AUD… now 1 CAD gets you 0.8011AUD… so, the CAD gets you less, which means the CAD depreciated (and the AUD appreciated) now we have to work out which is LEAST likely: a) if the CAD economy ran a current account deficit, this means that its importing more than its exporting… this puts upward pressure on the AUD (since they need AUD to pay for imports). b) if CAD economy grew at faster rate, i take this to mean that they had more money to buy overseas imports, and so, like above, this puts upward pressure on AUD. c) CAD govt -> expansionary MP… it does this by reducing interest rates. This increases the interest rate differential between Canada and Australia, increasing the financial flows towards Australia, thereby putting upward pressure on the AUD. d) expansionary FP. This means the CAD govt increases govt spending (or lowers taxes) thereby increasing the budget deficit. All this spending has to be financed somehow, yeh? the govt has to borrow money from the private sector (“crowding them out”) and pushing up interest rates in the process… the higher interest rates attract money from abroad, thus putting upward pressure on the CAD. so, after all that…i hope the answer is D

I concur …D expansionary fiscal policy causes crowding out effect->higher interest rates which causes CAD to appreciate.

Yup the correct answer is D. Rationale: 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 depreciate.