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Chapter 29: Problem 12

In \(2017,\) an article on bloomberg.com had the following headline: "The Australian Dollar's Outlook Darkens." The article stated, "The march of the Fed toward higher U.S. interest rates has also been a factor sapping optimism toward the Aussie [dollar]." Briefly explain the article's reasoning.

Short Answer

Expert verified
The march of the Fed towards higher US interest rates leads to the appreciation of the US dollar as it increases the demand for US investments. This results in the relative depreciation of other currencies, including the Australian Dollar if they don't experience a similar or higher rise in interest rates. Therefore, the darkening outlook for the Australian dollar means a potential decrease in its value compared to the US dollar.

Step by step solution

01

Understand the role of interest rates

Interest rates indicate the cost of borrowing. When a country increases its interest rates, financial foreign investors have an incentive to invest in that country to take advantage of the higher returns. This demand for their currency tends to increase its value.
02

Look at the March of the Fed

The term 'The march of the Fed' in the article represents the Federal Reserve's (Fed) actions to raise interest rates in the United States. When the Fed raises interest rates, investments in the US become more attractive leading to a higher demand for the US dollar. Consequently, the US dollar appreciates.
03

Effect on the Australian dollar

The rise of the US dollar implies a relative depreciation of other currencies against it, unless their respective economic factors change in a similar direction. Thus, if the Australian dollar does not experience a similar or higher increase in its interest rate, it will depreciate relative to the US dollar. This depreciation reflects as a 'darkening outlook' for the Australian dollar, which can discourage investments.

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Most popular questions from this chapter

An article in the Wall Street Journal stated: The U.S. dollar's more than \(20 \%\) rally since 2014 has been driven largely by what analyst call "divergence." While the Fed has been slowly tightening monetary policy amid an improving [U.S.] economy, central banks in Europe and Japan have continued to introduce stimulus as they struggle with stagnant growth and very low inflation. a. Which economic variable is "diverging" because of differences between the monetary policy of the Fed on the one hand and the monetary policies of the central banks of Europe and Japan on the other hand? b. Draw a graph of the demand and supply of U.S. dollars and show the effect of this "divergence" on the foreign exchange value of the dollar. Briefly explain what is happening in your graph.

Look again at Solved Problem \(29.3,\) where the saving and investment equation \(S=I+N X\) is derived. In deriving this equation, we assumed that national income was equal to \(Y\). But \(Y\) only includes income earned by households. In the modern U.S. economy, households receive substantial transfer payments-such as Social Security payments and unemployment insurance paymentsfrom the government. Suppose that we define national income as being equal to \(Y+T R,\) where \(T R\) equals government transfer payments, and we also define government spending as being equal to \(G+T R\). Show that after making these adjustments, we end up with the same saving and investment equation.

An investment analyst recommended that investors "gravitate toward the stronger currencies and countries that are running current-account and fiscal surpluses," such as South Korea and Taiwan. a. Holding all other factors constant, would we expect a country that is running a government budget surplus to have a currency that is increasing in value or decreasing in value? Briefly explain. b. Holding all other factors constant, would we expect a country that has a currency that is increasing in value to have an increasing or a decreasing current account surplus? Briefly explain. c. Is the combination of economic characteristics this analyst has identified likely to be commonly found among countries? Briefly explain.

Writing in the New York Times, Simon Johnson, an economist at MIT, made the argument that people outside the United States may at some point decide to "save less (in which case they may hold onto their existing United States government debt but not want to buy so much of new issues)." What does saving by people outside the United States have to do with sales of U.S. government debt? Does the level of domestic investment occurring in foreign countries matter for your answer? Briefly explain.

Why does fiscal policy have a smaller effect on aggregate demand in an open economy than in a closed economy?
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