Changes in Policies and Economic Conditions
Introduced| English | Meaning |
|---|---|
| interest rates/ˈɪntrest reɪts/ | Charges for borrowing, or returns on lending, expressed as percentages of the amount over a period. |
| inflation/ɪnˈfleɪʃn/ | A sustained increase in the general price level of goods and services. |
| income/ˈɪŋkʌm/ | Money received by a person or organisation over a period. |
| monetary policy/ˈmʌnɪtəri ˈpɒlɪsi/ | Actions by a monetary authority to influence interest rates, credit or money conditions in pursuit of economic objectives. |
| Fiscal policy/ˈfɪskl ˈpɒlɪsi/ | Government decisions about spending, taxation and borrowing intended to influence the economy. |
What moves the exchange rate
- Several forces shift currency demand and supply, moving the exchange rate.
- The big three: interest rates, inflation, and income.
- Government policy works through these same channels.
- Learn the three and you can predict almost any exchange-rate move.
If a country raises its interest rates (others steady), its currency tends to:
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Higher bond returns attract foreign money, raising currency demand.
Higher domestic inflation than the rest of the world tends to make a currency:
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Dearer goods lose foreign buyers, so demand for the currency falls.
Interest rates and inflation
- A change in interest rates 利率: raise them, and foreign investors want your bonds — they demand your currency, so it appreciates.
- A difference in inflation 通货膨胀: higher inflation at home makes your goods dearer, so foreigners buy fewer — demand falls and the currency depreciates.
- So high rates strengthen a currency; high inflation weakens it.
Does it appreciate or depreciate the dollar?
Higher domestic interest rates appreciate a currency; higher inflation or higher income (more imports) depreciate it.
When a country's income booms and imports surge, its currency tends to depreciate because residents:
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Buying imports means offering your currency — supply rises, the rate falls.
Income
- A change in income 收入: when a country's income grows, its residents buy more imports.
- To buy imports they supply more of their own currency, which tends to depreciate it.
- A booming economy can therefore weaken its own currency through extra imports.
- Notice this one works through the supply side, not demand.
Contractionary monetary policy, by raising interest rates, tends to weaken a currency.
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False. Higher interest rates attract foreign financial capital, which must buy the currency, so it tends to appreciate.
Which changes would appreciate a currency? (Select all that apply)
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Higher rates and bond demand raise currency demand; inflation and imports weaken it.
The US raises rates while others hold steady. The demand for dollars shifts:
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Investors buy dollars to hold higher-paying US bonds — demand right, dollar up.
Policy works the same way
- Contractionary monetary policy 货币政策 raises interest rates and tends to strengthen the currency.
- Fiscal policy 财政政策 that raises interest rates (through government borrowing) can do the same.
- Worked idea. The US central bank raises rates while others hold steady. Global investors move money into higher-paying US bonds, buying dollars first. Demand for dollars shifts right and the dollar appreciates.
- Higher interest rates draw in foreign money and lift the currency.
The exchange rate shifts with interest rates (higher → appreciate), inflation (higher → depreciate), and income (higher → more imports → depreciate). Policy works through these: contractionary monetary policy raises rates and strengthens the currency, as foreign investors buy it to hold higher-paying bonds.
Write from domestic inflation of 9 percent
- Domestic inflation is 9 percent. Inflation in the rest of the world is 2 percent.
- Say what happens to the currency.
Domestic inflation is 9 percent while inflation in the rest of the world is 2 percent. What tends to happen to the domestic currency, and why?
Buyers switch away from the country with the faster price rise.
What does inflation of 9 percent tend to do to the currency?
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Dearer exports lose foreign buyers, so demand for the currency falls. Other options — Appreciate it (because higher prices mean a stronger economy); Fix it (because world inflation is 2 percent).