# 3. The Currency Stabilization FundSuppose the Russian government recognizes that its reliance on oil exports makes it vulnerable to the Dutch Disease. On the one hand, if oil prices increase, the Russian ruble will appreciate, the real exchange rate will increase, and the nation’s exports will become more expensive for other countries to buy. On the other hand, if oil prices fall, the Russian ruble will depreciate, and the country’s revenues will decline. The Russian government creates a currency stabilization fund to maintain a stable exchange rate to avoid a negative outcome. To stabilize the value of a currency within a certain range, the stabilization fund managers take one of the following actions:- If the ruble depreciates below some threshold value (a floor) per ruble, the fund managers will purchase the excess supply of rubles in the international exchange market to increase the value of the ruble to at least the floor value.- If the ruble appreciates above some threshold value (a ceiling) per ruble, the fund managers will sell the excess supply of rubles to lower its value to at least the ceiling value.---### Consider the following scenario:Russia establishes a currency stabilization fund to keep the exchange rate between €3 per Russian ruble and €5 per Russian ruble. Initially, the market exchange rate is within the allowed range at €4 per Russian ruble, as shown by the intersection of the demand ($D_1$) and supply ($S_1$) curves for the Russian ruble on the following graph. Suppose that higher oil prices generated higher income for people in Russia, which increased demand for foreign-made goods, in particular for the goods made in Europe. As a result, the supply of rubles in the market for foreign exchange increased from $S_1$ to $S_2$. *Note: The detailed graph that represents the demand and supply curves is essential for understanding how these fluctuations affect the exchange rate within the specified range.* ### Explanation of the Graph#### Title: The Market for Foreign Exchange- **Axes**: - **X-axis**: Quantity (Millions of rubles) - **Y-axis**: Exchange Rate#### Lines:- **S₁ (Initial Supply Curve)**: Orange line indicating the initial supply.- **S₂ (New Supply Curve)**: Orange line shifted to the right, indicating an increase in the supply of rubles.- **D₁ (Demand Curve)**: Blue line indicating the demand for rubles.- **Ceiling and Floor**: Black horizontal lines indicating the maximum (ceiling) and minimum (floor) exchange rate levels.#### Symbol:- **Grey Star**: Represents the New Exchange Rate resulting from higher oil prices.### Effects of Increased Supply- **New Equilibrium**: The shift from S₁ to S₂ causes the exchange rate to rise above the ceiling value due to the increase in the supply of rubles.### Multiple Choice Question- **Question**: According to the graph, which of the following correctly describes the effect of the increase in the supply of rubles on the market for foreign exchange in Russia? - The Russian ruble depreciates, and the exchange rate falls below the floor value. - The Russian ruble appreciates, and the exchange rate rises to the ceiling value. - **The Russian ruble appreciates, and the exchange rate rises above the ceiling value.** (Correct Option) - The Russian ruble depreciates, and the exchange rate falls to the floor value.### Stabilization Fund Manager's Role- **Instruction**: Use the purple line (diamond symbol) to show the stabilization process. Adjust the supply or demand curve to meet the official exchange requirements. - **Action Required**: - Managers will effectively **sell** a certain amount of rubles. - The exact amount remains to be filled in the blank.- **Hint**: Draw a new supply or demand curve parallel to the existing curves to see the impact.This explanation serves as an educational walkthrough for understanding the dynamics of foreign exchange markets and the influence of changing supply conditions, particularly in the context of higher oil prices affecting the ruble's value.

An exchange rate is the rate at which one currency can be converted into another currency. It is…

On the following graph, use the grey point (star symbol) to show the new exchange rate resulting from higher oil prices. The market for foreign exchange 10 S, New Exchange Rate 8 Action Ceiling Floor 2 D, 20 40 60 80 100 QUANTITY (Millions of rubles) According to the graph, which of the following correctly describes the effect of the increase in the supply of rubles on the market for foreign exchange in Russia? O The Russian ruble depreciates, and the exchange rate falls below the floor value. O The Russian ruble appreciates, and the exchange rate rises to the ceiling value. O The Russian ruble appreciates, and the exchange rate rises above the ceiling value. O The Russian ruble depreciates, and the exchange rate falls to the floor value. On the previous graph, use the purple line (diamond symbol) show how the stabilization fund managers have to adjust the value of the Russian ruble to ensure it meets the official requirement. (Hint: You need to draw either a new supply curve or a new demand curve. Make sure the new curve is parallel to the given supply or demand curve. Position your cursor over the given curves to see their slopes.) The managers will effectively sell million rubles. EXCHANGE RATE

On the following graph, use the grey point (star symbol) to show the new exchange rate resulting from higher oil prices. The market for foreign exchange 10 S, New Exchange Rate 8 Action Ceiling Floor 2 D, 20 40 60 80 100 QUANTITY (Millions of rubles) According to the graph, which of the following correctly describes the effect of the increase in the supply of rubles on the market for foreign exchange in Russia? O The Russian ruble depreciates, and the exchange rate falls below the floor value. O The Russian ruble appreciates, and the exchange rate rises to the ceiling value. O The Russian ruble appreciates, and the exchange rate rises above the ceiling value. O The Russian ruble depreciates, and the exchange rate falls to the floor value. On the previous graph, use the purple line (diamond symbol) show how the stabilization fund managers have to adjust the value of the Russian ruble to ensure it meets the official requirement. (Hint: You need to draw either a new supply curve or a new demand curve. Make sure the new curve is parallel to the given supply or demand curve. Position your cursor over the given curves to see their slopes.) The managers will effectively sell million rubles. EXCHANGE RATE

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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