AFROM THE GIVEN EXCHANGE RATES, WE DETERMINE THAT THE FOREIGN CURR...

From the given exchange rates, we determine that the foreign currency (FC) has depreciated against the

U.S. Dollar (it now takes more units of FC to buy one dollar). An unanticipated shift to contractionary

monetary policy would lead to currency appreciation. The contractionary policy leads to lower economic

growth, a lower inflation rate, and higher real interest rates. Domestic products are less expensive, foreign

investment is encouraged, and exports increase.

The other statements are true. The following factors will cause a nation’s currency to

depreciate:

•

High income growth (relative to trading partners) causes imports (and the demand for foreign

currency) to exceed exports (and the demand for domestic currency).

•

Higher rate of inflation than trading partners (domestic citizens increase their demand for foreign

goods and thus foreign currency).

•

Lower domestic real interest rates (than those abroad). The country’s assets are less attractive to

foreigners.