The increase in stocks and wealth in USA led to the increase in the interest rate in USA. In case of bilateral exchange rate, such as USD/GBP, USD is the base currency of them. Trade weighted index is considered about 120 for USA. This influences the exchange rates to the other currency that is GBP because of the change in economic conditions in USA. This happens due to various reasons, such as political focus, stock market improvement and increase in wealth. The increase in interest rate will attract more foreign investment due to the decrease in USD exchange rate with respect to GBP.
Scenario B is not quite as sanguine: Suppose stock prices – and therefore wealth – just remain about where they are now, so interest rates in the U.S. stay the same. What are the implications for the dollar?
In case of USA, stock prices and wealth remain same, which keeps the interest rate almost constant. This will not affect the dollar much because the price will be flexible in the market. And hence it would not either go down or up. With respect to the other currencies, the price will not fluctuate more in USA. This will result to more stabilized economy, which would attract investors as well.
Suppose stock prices stay the same but the Fed raises rates four times this year. Would the dollar be higher or lower by year’s end?
Keeping stocks at the same price but increase the rates four times will influence the dollar for sure. The inflation rate will increase. Then the domestic costs will rise. This will have the tendency to increase country’s GDP. However, this will increase the demand for imports. More imports will cause the dollar to be slightly lower than the market value.
The trade weighted value of the dollar offers a broad view of the dollar’s value in the world markets for goods and services. Listed below are bilateral trade data for the four countries with which the US trades most, for the years 2014 and 2015.
Calculate the percent change in the bilateral exchange rates from year-end 2015 to year-end 2016.
Calculate the percent change in the trade weighted index from year-end 2015 to year-end 2016.
The weighted index on an average is 5.8% for China vs Canada and for others the average is around 10%.
Listed below are the December 2016 measures of the dollar cost of a Big Mac in each of the four countries. For comparison, the price of a Big Mac in the US was $5.00. Is there a connection between these data and your answer to part a? Explain.
Dollar Cost of Big Mac In…
The price of each Big Mac in US = US $5.00
Yes, the above four countries’ price for big mac explains that exchange rate in USA was higher than the other four countries means that the currency is stronger enough. This also indicates that the people in USA have more wealth.