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Australian investment - Fixed Exchange Rate System

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Refer to graph attached.

1. Starting at equilibrium income $50 billion, where (S - I)0 intersects (X - M) 0, suppose that worsening economic conditions abroad lead to an autonomous decrease in Australian exports of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

2. Starting at equilibrium income $50 billion, where (S - I) 0 intersects (X - M) 0, suppose that improving profit expectations lead to an autonomous increase in Australian investment of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

3. Starting at equilibrium income $50 billion, where (S - I) 0 intersects (X - M) 0, suppose that increased thriftiness leads to an autonomous increase in Australian saving of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

4. Starting at equilibrium income $50 billion, where (S - I) 0 intersects (X - M) 0, suppose that changing preferences lead to an autonomous increase in Australian imports of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

5. As indicated by the slope of the (X - M) schedule and (S - I) schedule, what is the value of Australia's foreign trade multiplier?
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Question 1
If there is an autonomous decrease in Australian exports (X), this means that the (X-M) schedule must move down, because now net exports will be lower for any income level. The (S-I) schedule wil remain unchanged.

So basically, what happens here is that (S-I) remain at (S-I)0, while (X-M) moves to (X-M)2 (notice that (X-M)2 is exactly the same as (X-M)0 minus 5 billion, which is the amount by which exports fall).

Looking at where the intersection between these lines happen, we conclude that income will fall to $40 billion and there will be a trade balance (X-M) deficit of -2.5 billion. The result is then that the Australian economy will enter a recession (because its aggregate demand -specifically, its exports component- falls) and will run a trade deficit, as a result lower exports.

Question 2
If there is an autonomous increase in Australian investment (I) of 5 billion, we can expect the (S-I) schedule to fall by 5 billion. (S-I) will be 5 billion lower for any income level, so its schedule will shift down. The (X-M) schedule remains unchanged, and the (S-I) schedule will move from (S-I)0 to (S-I)1.

We conclude then that the new income level will ...

Solution Summary

Australian investment is assessed in these problems.

$2.19
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1) Some people are arguing that the Chinese Yuan Renminbi (CNY) could take over the US dollar and the Renminbi will become the next reserve currency. Please read the following articles:

Frankel, J. (2011). The rise of the Renminbi as international currency: Historical precedents. Retrieved May, 2012, from http://www.voxeu.org/index.php?q=node/7075

US Department of Treasury (2012). Renminbi as the next reserve currency: Potential, challenges, and implications. Retrieved May, 2012, from https://infocus.credit-suisse.com/data/_product_documents/_articles/342047/Amia_Liu.PDF

Oliver, C. (2012). China's Yuan set for more international role. Retrieved May, 2012, from http://articles.marketwatch.com/2012-01-26/investing/30734300_1_chinese-currency-yuan-currency-policy

Based on your analysis and findings, will Renminbi replace the US Dollar as the world's most popular currencies to hold? Will Renminbi become the next reserve currency? Why? Please explain your reasoning.

2) Is the exchange rate of the Mexican Peso (one of the emerging market currencies) determined in a fixed or in a floating exchange rate system? Please explain your reasoning.

3) Is the exchange rate of the Indian Rupee (one of the emerging market currencies) determined in a fixed or in a floating exchange rate system? Please explain your reasoning.

4) To what extent is the Emerging Market (EM) Currency trading risky? Please explain your reasoning.

5) Based on your analysis and findings, what would you recommend to international market currency investors?

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