The US Fed has increased the money supply through massive open market purchases

Question

The US Fed has increased the money supply through massive open market purchases of financial securities.

a) In the graph, show the shift in the supply or demand curve for US dollars and the effect on the exchange rate.

b) Does the US dollar appreciate or depreciate relative to other currencies?

c) Will this new exchange rate make US exports more or less expensive for foreign buyers?

d) Recall that GDP = C + I + G + NE. If all other factors are unchanged (ceteris paribus), explain the predicted effect on US GDP?

Explanation / Answer

a) When the US fed increase the money supply through massive open market purchases, the supply curve shift downwards whereas the demand curve remains the same. Hence, demand and supply curve intersect at lower exchange rate price / dollar as compared to innitial equilibrium.Hence, the exchange rate for dollar goes down.

b) Due to massive supply of dollar, the exchange rate of dollar goes down. Hence, US dollar depreciate relative to other currencies.

c) Due to US dollar depreciation, other countries find it more cheaper to import from US because of stronger domestic currency. Hence, US exports become more cheaper for foreign buyers.

d) The increase in money supply will lead to an increase in consumer spending. This will shift aggregate demand curve to the right. Now, to match up with higher demand and increase in money supply will lead to higher prices among markets. Hence, there will be more real potential output. The result is higher predicted US GDP.

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