Implications of a Revised Peg
Response to the following problem:
The country of Zapakar has much international trade with the United States and other countries as it has no significant barriers on trade or capital flows. Many firms in Zapakar export common products (denominated in zaps) that serve as substitutes for products produced in the United States and many other countries. Zapakar's currency (called the zap) has been pegged at 8 zaps ¼ $1 for the last several years. Yesterday, the government of Zapakar reset the zap's currency value so that it is now pegged at 7 zaps ¼ $1.
a. How should this adjustment in the pegged rate against the dollar affect the volume of exports by Zapakar firms to the United States?
b. Will this adjustment in the pegged rate against the dollar affect the volume of exports by Zapakar firms to non-U.S. countries? If so, explain.
c. Assume that the Federal Reserve significantly raises U.S. interest rates today. Do you think Zapakar's interest rate would increase, decrease, or remain the same?