Overview
Purpose:
To show the effect of exchange rates on trade and domestic growth and inflation, and the effect of domestic economic events of foreign exchange rates.
Objectives:
1. If the value of the dollar compared to other currencies increases, goods exported from the U.S. will cost more in terms of foreign currencies than before, and imports will cost less than before. Therefore, net exports will tend to fall, depressing economic growth in the U.S., and stimulating growth overseas.
2. A country’s ability to import and export changes over time because of underlying changes in relative wage rates, productivity, technology, etc. When such long-term changes occur, either the exchange rates have to be realigned or the country which has lost its competitive ability will have to endure a long period of slow growth in order to restore the trade balance.
3. The following will tend to cause the dollar to fall vis-ŕ-vis foreign currencies:
a) a higher real growth rate in the U.S. (because it will cause net exports to fall)
b) a higher inflation rate in the U.S. (because people will want to hold currencies that are not depreciating)
c) a lower interest rate in the U.S. (because people will convert their dollars to foreign currencies to earn high interest)
d) pessimism regarding the relative value of investments opportunities in the U.S.
The converse of these effects will cause the dollar to rise.
| Key Economic Concepts government intervention in currency markets, economic activity, inflation, interest rates, and exchange rates, gold standard, balance of payment, deficit or surplus, flexible exchange rates, purchasing power parity. |
| Contemporary Issues In the three years after the launch of the euro (Europe’s new single currency) in January 1999, it lost close to a third of its value against the dollar. Many European leaders were embarrassed by the weakness of the fledgling currency and hoped that it would strengthen. They got their wish. Between January 2002 and the summer of 2003, the euro regained all the ground that it had lost against the dollar. However, the stronger currency was a mixed blessing. In 2003, many of the key European economies (including Germany) were in or close to being in a recession. A stronger euro only hurt them, by making European exports more expensive. Is a strong or a weak currency inherently good or bad? Under what circumstances might a strong or a weak currency be beneficial for an economy? |
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