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Paged 361 1a. trade in services, payment b. merchandise trade, receipt c. transfers, payment d. investment income, receipt 2a. financial account, portfolio investment, receipt. b. financial account, direct investment, payment c. capital account, receipt d. financial account, other financial investments, receipt Page 368 1a. A fall in Canadian interest rates makes Canadian bonds less appealing to financial investors in both Canada and the US. As Americans purchase fewer Canadian bonds, the demand for Canadian dollars in this foreign exchange market decreases. Meanwhile, because Canadians are more likely to buy American rather than Canadian bonds, the supply of Canadian dollars in this market increases. Both movements cause a fall in the price of the Canadian dollar in terms of US dollars. b. As Americans make fewer financial investments in Canada, the demand for Canadian dollars in this foreign exchange market decreases. Meanwhile, as Canadians make fewer financial investments in Canada, they increase the amount of financial investments they make in the US, which increases the supply of Canadian dollars in this market. Both movements cause a fall in the price of Canadian dollars in terms of US dollars c. Falling real output in Canada means a drop in Canadian spending on imports. This decreases the supply of Canadian dollars in this foreign exchange market. Constant real output in the US means that there is no change in the demand for Canadian dollars in this market. The result of the first trend is a rise in the value of the Canadian dollar in terms of US dollars. 2. 3a. Given an expectation that higher interest rates will push up the international value of the Canadian dollar, speculators will purchase Canadian dollars. b. Given an expectation that higher inflation rates will put downward pressure on the Canadian dollar, speculators will sell Canadian dollars. c. With a lower risk of Quebec separation, there will be an expectation of a higher value of the Canadian dollar, which will cause speculators to purchase Canadian dollars. Page 373 1a. A target value for the Canadian dollar set below the equilibrium level requires that the Bank of Canada sell Canadian dollars and buy foreign currency b. Because the Bank of Canada is selling Canadian dollars, the “changes in official reserves” account is negative, and there is a balance-of-payments surplus to ensure that the overall balance of payments sum to zero. c. 2a. With a fixed exchange rate set below the Canadian dollar’s equilibrium value, Canadian exports are relatively cheap and American imports are expensive. The beneficial result is an increase in net exports, which expands aggregate demand and pushes up real output and employment. The cost of this policy is higher inflation, as well as the possibility that Canada’s main trading partners (in particular, the US) will decrease the value of the US dollar in terms of the Canadian dollar. In practical terms, it is the inflation risk that is most significant in the Canadian context. b. If the fixed exchange rate is set above the Canadian dollar’s equilibrium value, American exports are relatively cheap, with the beneficial effect that inflation is reduced. The cost of this policy is associated with the fact that Canadian exports become relatively more expensive at the same time as American imports become cheaper. Canada’s net exports are reduced, pushing down aggregate demand, real output and employment. |