Chapter 15: Exchange rates and the balance of payments ? 0 Number of pounds Figu

Question

Chapter 15: Exchange rates and the balance of payments ? 0 Number of pounds Figure 15.10 The foreign exchange market 2.) Figure 15.10 shows the position in the foreign exchange market DD S the demand schedule for sterling and SS the supply schedule. Assume a two-country world (the UK and the eurozone): (a) Explain briefly how the two schedules arise. (b) Identify the exchange rate that would prevail under a clean float. What would be INT the state of the overall balance of payments at this exchange rate? (c) Suppose the exchange rate were set at OA under a fixed exchange rate r egime What intervention would be required by the central bank? What would be the state of the balance of payments? payments and the necessary central bank intervention. what sorts of measures would be required? (d) Suppose the exchange rate was set at OC. Identify the situation of the balance of (e) If the authorities wished to maintain the exchange rate at OC in the long run,

Explanation / Answer

The demand schedule of pound sterling slopes downwards due to the inverse relationship between demand for pound sterling and sterling-euro foreign exchange rate.

The supply schedule of pound sterling slopes upwards because the British would be willing to buy more euros as the euro becomes cheaper and therefore the supply of pound sterling increases.

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