Answer to Question #160979 in Macroeconomics for hellen

Question

“If a country becomes more productive than another country, its currency should always appreciate against the other’s currency”. Is this statement true or false? Explain your reasoning with reference to the theory of exchange rate determination and international monetary system including gold standard, fixed exchange rate regime and floating exchange rate regime. 

Answer 1

Currency Appreciation

The statement is true because the increase in country productivity increases its revenue since it will be able to export more goods. Increase in exports leads to the appreciation of the currency of that country. In this case, the exchange rate determination theory determines the currency's strength due to the demand and supply of money (Bilson, Marston, & National Bureau of Economic Research, 1984). In this case, the country's demand for money with increased productivity will increase due to the increase in exports. Therefore the other country will be demanding more the country's exports. This leads the other country to exchange more currency to buy more exports (Shenkar, & Luo, 2004). This exchange rate system is a floating exchange rate system since market forces drive it. The increase in exports from the increased productivity country has led to an increase in demand for its currency.

 

References

Bilson, J. F. O., Marston, R. C., & National Bureau of Economic Research. (, 1984). Exchange rate theory and practice. Chicago: University of Chicago Press.

 

Shenkar, O., & Luo, Y. (2004). International business. New York: Wiley.