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Exchange Rate Determinants - The U.S. economy seems to be overheating, with rapid economic growth and...

Exchange Rate Determinants -

The U.S. economy seems to be overheating, with rapid economic growth and low unemployment. The monthly national business activity level is even higher than expected (as measured by new orders to factories and unemployment figures). This news leads to renewed fears of inflationary pressures and likely action by the Federal Reserve, the monetary authority, to raise interest rates to suppress the expected high inflation and slow the economy down.

a) Based on the traditional flow market approach, discuss whether this news is good or bad for the exchange rate?

b) Based on the asset market approach, discuss whether this news is good or bad for the exchange rate?

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Answer #1

Answer:

a) Based on the traditional flow market approach, discuss whether this news is good or bad for the exchange rate?

Ans: when interest rates are higher, it attracts more foreign exchange and increases the demand for the home country’s currency. So, this news is good for exchange rate.

b) Based on the asset market approach, discuss whether this news is good or bad for the exchange rate?

Ans: According to the asst market approach, Exchange rates are determined by the supply and demand for financial assets of a wide variety. So, when interest rates are higher, demand for financial assets increases. So, this news is good for exchange rate.

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