What is the probable effect of each of the following on the

What is the probable effect of each of the following on the exchange rate of a country, other things being equal? The quantity of oil imports is greatly decreased, but the value of imported oil is higher due to price increases. The country\'s inflation rate falls well below that of its trading partners. Rising labor costs of the country\'s manufacturers lead to a worsening ability to compete in world markets. The government greatly expands its gifts of food and machinery to developing countries. A major boom occurs with rising employment. The central bank raises interest rates sharply. More domestic oil is discovered and developed. Which two of these do you think would have the greatest impact on the exchange rate?

Solution

Rise in value of oil import despite the fall in its quantity of import means price paid per unit has risen. This occurs if a currency depreciates.

Fall in inflation rate raises domestic interest rate. This will make inflow of capital and currency will appreciate if capital is mobile, Marshall-Lerner condition holds, economy is competitive and flexible exhange rate is adopted.

Rising cost makes country less competitive and import more hence, by raising exchange rate of domestic currency.

Government expenditure will raise domestic income via multiplier and this will in turn, raise up the import, thereby, depreciation of currency occurs if flexible exchange rate is permitted under competitive structure.

Rise in employment will raise income, thereby, the former case is followed simply.

Rise in domestic interest rates will enhance inflow of capital and appreciation will occur.

This will make the import reduced and thereby, a fall in exchange rate.

Govt. expenditure rise and Central bank\'s declaration to raise up interest rate will have greatest impact as these directly affect the capital accounts.