Question

Suppose a new and deadly strain of the COVID-19 that spreads through plastic has been discovered in USA. Majority of merchants and consumers completely switch to cash since they are afraid to use credit cards for transactions. Using the asset approach, analyze the short-run effects of this temporary shock on the $/€ exchange rate, USD interest rate and the US price level, graphically and verbally.

Answer 1

In the short run, a switch to cash due to a new strain of COVID-19 in the USA would affect the exchange rate, interest rate, and price level. The USD would depreciate against the euro, the US interest rates would decrease, and the US price level would decrease.

Step-by-step explanation:

In the short run, if a new and deadly strain of COVID-19 that spreads through plastic is discovered in the USA, causing a majority of merchants and consumers to switch to cash, it would have several effects on the exchange rate, interest rate, and price level.

The temporary shock of increased cash usage would lead to a higher demand for cash, resulting in an increase in the supply of USD in the foreign exchange market. This would cause the value of the USD to depreciate, leading to a decrease in the $/€ exchange rate.

The increased demand for cash could also lead to a decrease in the demand for credit and a shift to a more cash-based economy. This decrease in demand for credit would lower the interest rates in the US.

Additionally, the increased use of cash could lead to a decrease in the velocity of money and a decrease in the money supply. This decrease in the money supply would lead to a decrease in the US price level.