Excellent ECON question

R

rene01

New member
Joined
Jun 18, 2026
Messages
0
Reaction score
0
Suppose the money supply in Canada has grown by 3%, 4% 5% in 2004, 2005 and 2006 respectively. Over the same period, the budget deficit has grown from approx. $13o bn to 182 bn.

In an effort to control the economy, policy makers are suggesting a sudden change to either a restrictive monetary or fiscal policy. What effect would the sudden policy change have on the Canadian currency and capital account?

Monetary Policy Fiscal Policy
a) Capital account surplus Currency appreciation
b) Currency appreciation Capital account deficit
c) Capital account deficit Currency depreciation
d) Currency depreciation Capital account surplus
 
I'm inclined to use the Mundell-Fleming model to solve it (even though I don't recall CFAI teaching it). I get the LM curve shifting south-east and IS curve shifting north-east, so that the equilibrium is to the right of BP curve... but I just forgot the meaning of this... could anyone help out? Joey? Thanks :P
 
I'm thinking A, and here's why, but please by all means correct me if I'm wrong.

In order to control the budget deficit, which is growing as the money supply continues to shift to the right, the central bank would want to reduce the amount of currency, thereby raising interest rates, increasing the supply of money at those interest rates and decreasing the demand for money. That increase in interest rates is unappealing to consumers who could save now and get more later and for businesses who would have to finance their loans at higher interest rates. This would cause a decrease in aggregate demand, which is reflected in the exchange of goods and services component of the current account which would go into a deficit. The capital account therefore would move in the opposite direction toward a surplus. The currency in all of this would appreciate because the interest rate received on the currency is greater than it was before, thereby increasing foreigners' demand for it, which in turn is shown through the surplus in the capital account which accounts for the flow of funds into a country from abroad.

I think I got that down -- that sound right to you guys?
 
I also say A. My not so expert opinion is that a rise in interest rates will draw money into Canada causing currency appreciation and a capital account surplus due to foreign investment.
 
Bodymore Wrote:
-------------------------------------------------------
> I also say A. My not so expert opinion is that a
> rise in interest rates will draw money into Canada
> causing currency appreciation and a capital
> account surplus due to foreign investment.


Same logic I used. Another vote for A.
 
sorry to dissapoint you all!!!

its B!

Another reason to love Economics.

The reason is due to the restrictive Monetary policy.. there is a shortage of funds.. rates go up.. right away it attracts forigners to invest in our high rate.. so tehre is a demand for dollars... Currency appreciation

The restrictive Fiscal policy is followed by higher taxes and less gov spending.. econ slows down...dollar becomes stronger due to GDP shrinking-lower inflation-lower prices- so more imports.. less exports
 
F! I guess this just goes to show that I need to do a ton more work on Econ.... I am not sure I fully follow the second part of that logic though.
 
rene01 Wrote:
-------------------------------------------------------
> sorry to dissapoint you all!!!
>
> its B!
>
> Another reason to love Economics.
>
> The reason is due to the restrictive Monetary
> policy.. there is a shortage of funds.. rates go
> up.. right away it attracts forigners to invest in
> our high rate.. so tehre is a demand for
> dollars... Currency appreciation
>
> The restrictive Fiscal policy is followed by
> higher taxes and less gov spending.. econ slows
> down...dollar becomes stronger due to GDP
> shrinking-lower inflation-lower prices- so more
> imports.. less exports

the second part doesnt even make sense, if inflation drops, domestic prices are lower, and domestic producers would export more.

moreover, if there is an inflow of capital due to increased demand of CAD, then the capital account should go up, not down.
 
alright this q was bothering me


money supply goes up
loanable funds goes up
interest rates goes down
domestic investment goes up / foreign investment goes down
demand for $ goes down
$ goes down
exchange rate goes down
exports goes up
current account goes up
capital account goes down
 
The clue it was B is that currency is a Monetary Policy issue.
 
pacmandefense Wrote:

> the second part doesnt even make sense, if
> inflation drops, domestic prices are lower, and
> domestic producers would export more.
>
> moreover, if there is an inflow of capital due to
> increased demand of CAD, then the capital account
> should go up, not down.

A restrictive fiscal policy would make the business environment in Canada unfavourable (higher taxes means people will spend less, business will be taxed higher on their profits) and thus, attractive investment opportunities will be discovered abroad with higher returns. Thus, capital outflow (more investment abroad, less investment in Canada) would result in a capital account deficit as domestic ownership of foreign assets increase.

-----------------------------------------
Feel free to add me on Facebook
http://www.facebook.com/people/Jyot-Chadha/31003831
CFA Level 2 Candidate - June '09



Edited 1 time(s). Last edit at Saturday, January 31, 2009 at 05:03AM by chad17.
 
The clue it was B is that currency is a Monetary Policy issue.
 
completely agree with Chad. Here's another perspective:
Since the monetary policy change is restrictive they would decrease the money supply causing increase in the interest rate. This would attract foreign investments causing the canadian dollar to appreciate.
This would mean that the imports rise and the exports fall causing a trade account deficit.
Thats how I thought of it.
 
Would like to ask about the definition of Capital Account, Current Account and Balance of Payment in CFA?

The definition taught by my school are below which I think is quite vague.

Current Account = Export - Import
Capital Account = Capital Inflow - Capital Outflow
Balance of Payment = CA + KA (Capital Account)

Best Regards,
Collin Yeo
http://collinyeo.blogspot.com
 
You must log in or register to reply here.
Back
Top