Question 4:Exchange Rate Effects of Monetary Policy-25 marks in total

[Please notethat you need to completedrawing theExchange Rate diagram on your own piece of paperas you explain your answers for part (a) of this question. Take a photo-shot (or screen short) of the completeddiagram ONLYandupload itin the uploading section following this question. However, all your explanations MUST be written in the space provided following the question in the online exam paper]

In addition to fiscal policy measure, many countries have also introduced monetary policy measures to overcome the economic crisis caused by the COVID-19 outbreak. In March 2020, the US Federal Reserve lowered its interest rate significantly to 0.00-0.25% to help small and medium-sized businesses hit by the COVID-19 pandemic access affordable credit, making the US interest rate one of the lowest in the world. Economic analysts say that the US Federal Reserve is likely to keep its zero-interest rate until 2023.

For a simplification of the economic analysis, assume that the US governmentkeeps its fiscal policy and everything else unchanged. As a result of interest rate cut in the United States, the US interest rate is currently much lower than the interest rate in China.Given the interest rate change in the United States,

(a)Discuss howyou would expect a decrease in interest rate in the United States to affect thequantity of money,value of US dollar,demand forandsupply ofUS dollar, and theexchange rate(depreciation or appreciation) against ChineseYuan(currency). In your discussion, use the exchange rate diagram below as a starting point for your graphical analysis andcomplete the diagramshowing the movement of US exchange rate against ChineseYuan,Yuan/US$. (hint: use demand for and supply of US dollar).(15 marks)

(b)Discusshow the change in the US exchange rate against ChineseYuanis expected influenceexports,imports and the current account balance(improve or worsen) of theUnited States and China.(10 marks)