Mar 13 2008
Will the Fed’s easy money policy fuel global inflation?
Published by Jason Welker at 7:26 am under AD/AS Model,Exchange Rates,Foreign exchange markets,Globalization,Inflation,Macroeconomics,Monetary Policy,Money Market,Recession
Inflation Reality Check(The Korea Times)
Harvard Economist Kenneth Rogoff points out that inflation is a major problem in many of the world’s largest economies today:
Inflation in Russia, Vietnam, Argentina, and Venezuela is solidly in double digits, to name just a few possibilities.
Indeed, except for deflation-ridden Japan, central bankers could meet just about anywhere and see high and rising inflation. Chinese authorities are so worried by their country’s 7 percent inflation they are copying India and imposing price controls on food.
Even the United States had inflation at 4 percent last year, though the Federal Reserve is somehow convinced that most people won’t notice.
Usually, inflation can be combatted with restrictive monetary policy, or the selling of bonds on the open market, which reduces the money supply, raises interest rates and slows down consumption and investment, and thus the pressure on prices in the economy. Today, however, the US Fed is in the process of expanding money supply and lowering interest rates, in an attempt to avoid a recession at home.
In a world of isolated economies, the US monetary policy would only affect the US economy; however, today the US economy finds itself intertwined in complex ways with other economies of the world.
America’s inflation would be contained but for the fact that so many countries, from the Middle East to Asia, effectively tie their currencies to the dollar. Others, such as Russia and Argentina, do not literally peg to the dollar but nevertheless try to smooth movements.
As a result, whenever the Fed cuts interest rates, it puts pressure on the whole “dollar bloc” to follow suit, lest their currencies appreciate as investors seek higher yields.
Looser U.S. monetary policy has thus set the tempo for inflation in a significant chunk ? perhaps as much as 60 percent ? of the global economy.
The reason other countries must mimic US monetary policies has to do with exchange rates, which many countries try to peg to varying degrees to the value of the dollar. One of the determinants of exchange rates is relative interest rates between countries. If the US lowers interest rates, and a country like Argentina keep rates high, global investors looking for a return on their savings will take their money out of US savings accounts and deposit it in Argentinian savings accounts, where they can earn a greater interest rate. In order to save in Argentina, investors need to convert their dollars to Argentinian pesos, driving up demand for pesos and the dollar/peso exchange rate. A stronger peso could have negative impacts on demand for Argentina’s exports as they become more expensive to foreign consumers. In order to avoid appreciation of its currency and declining demand for its exports, Argentina is thus forced to lower its own interest rates as the Fed cuts those in the US.
When you consider that much of the world adjusts its currency in relation to the dollar, you can see how an easy money policy in the US could lead to falling interest rates worldwide, triggering all sorts of new consumption and investment, driving price levels ever higher.
There is hope for curing the inflation problem. Relief may come at a price for Americans, however:
If the U.S. tips from mild recession into deep recession, the global deflationary implications will cancel out some of the inflationary pressures the world is facing.
Global commodity prices will collapse, and prices for many goods and services will stop rising so quickly as unemployment and excess capacity grow.
Of course, a U.S. recession will also bring further Fed interest-rate cuts, which will exacerbate problems later. But inflation pressures will be even worse if the U.S. recession remains mild and global growth remains solid.
Once again the Fed’s challenge of balancing unemployment, inflation, growth and recession is made clear. The choice of several major world economies to affix their currencies’ values to that of the dollar makes the challenge ever more dire for Mr. Bernanke.
Discussion Questions:
- If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
- Why are lower world interest rates inflationary?
- What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
- Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
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About the author: Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course.
Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this authorRelated posts:
If a US interest rate cut is not matched by countries that tie their currency to the dollar, the value of those countries’ currencies would rise. Similarly, the Euro would appreciate if the ECB does not start cutting interest rates soon.
Lower world interest rates are inflationary because these lower rates offer higher incentives for people to borrow money from commercial banks, therefore increasing consumption and investment, raising AD and thus pushing up the general price level. The rise in AD is part of the intended effect of the lower interest rates as countries fear that the appreciation of their own currencies arising from a stable interest rate would reduce demand for exports, and thus reduce AD. The interconnections between countries thanks to globalization will trigger a domino effect of dropping interest rates and inflation after the US initiates the process.
A US recession might counter the inflationary pressure as the drop in demand will drive down global commodity prices, and the prices of other goods and services will drop as well when unemployment and excess capacity emerge.
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If ECB does not cut its interest rate soon, demand for euro will increase, forcing interest rate to climb. As a result, investment decreases and net export decreases. The initial increase in the demand in euro is a byproduct of US's monetary policy. It can be seen in the transition below:
Fed buying bonds–>demand for bonds increase, interest rate decrease–> demand for dollar decrease and demand for euro increase–>Euro interest rate increase and net export decrease–> AD of Europe decrease
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If the US interest rate cut is not met by other countries that tie their currency to the dollar, the demand for their currency will rise and therefore the value of their currency will appreciate. This will cause lower exports since their products are becoming more expensive.
Lowering world interest rates will drive up investment and consumption and therefore prive levels will rise.
If the European Central Bank does not cut interest rates, demand for Euros will go up and the currency will appreciate.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
The countries currencies would appreciate in value.
Lower interest rates means more investment and consumption causing aggregate demand to increase causing an upward shift of price level.
The currency will appreciate and demand for the Euro will go up.
A US recession would mean that global demand would go down since unemployment would rise and excess capacity would also increase causing a decrease in commodity prices. This basically means it would slow the growth of prices on goods.
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As the Fed pours more money into our economy, we watch as the Dow seems to slowly rise – or at least not fall so quickly.
As was mentioned in the article, the supply of currency in the US is expanding (due to the Fed's latest move) and interest rates falling. This move seems a bit backwards to me; if inflation "can be combatted with restrictive monetary policy," why are we adding more money? To help in the short run, so we don't plunge further into the abyss? By now, I'm sure all of our Econ teachers have pounded into our heads the principle that if something is good for an economy in the short run, it's bad for the long run, and vice versa. So my question is, is the government really worried about keeping us afloat or about looking like they're doing something so that they won't get criticized further down the road?
Last I checked, if you screw up now, you have to fix it later. So doesn't it make more sense to just work a bit more slowly and fix things for the long run? In stead of fixing things for now and then refixing them later? And then again later? And so on. You get my point.
Don't forget about those interest rates – with interest rates falling, fewer nations will want to buy US bonds, which means we'll be less popular, and ultimately, with less money. A 'weak' dollar isn't all bad; it hurts some, but helps others. Same with a strong dollar [but that's a different article]. Other countries are more interested in our exports since they can buy more American with, say, the Euro. More bang for their buck, right? And a larger amount of exports than imports will only further help our economy. Why not at least try to lessen our trade deficit?
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, the value of those countries’ currencies will be even higher.
Lower world interest rates inflationary because people can then borrow money from commercial banks easier, so consuption and investment become higher, which drives up the prices.
If the ECB does not start cutting interest rates soon, the amount of euro demanded would be higher.
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Wow the devaluing USD is really affecting global economics, and I think that although the interest rate may affect the value of the dollar in various nations, and hence probably negatively impacting these nations in causing inflation, the biggest reason the weakening USD is affecting global inflation is because oil prices are so dependent on the USD. With a weaker USD, and lower purchasing power by the oil suppliers, the rise in energy costs makes perfect sense, although for most of us, that means we should perhaps abandon our constant use of drivers and spend time exploring Shanghai's local public transport!
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1.) If the U.S. interest rate cut is not matched by other countries that tie their currency to the dollar, the value of those other countries' currencies will appreciate.
2.) Lower interest rates would mean increase investment and consumer spending. In turn, this would shift the AD curve to the right thereby increasing the price level.
3.) If the ECB does not start cutting its interest rates soon, the demand for the Euro will increase.
4.) The recession in the U.S. would decrease the global demand, and the global commodity prices would decrease as well. Also, unemployment will rise.
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1.) If the U.S. interest rate cut is not matched by other countries that tie their currency to the dollar, the value of those other countries' currencies will appreciate.
2.) Lower interest rates would mean increase investment and consumer spending. In turn, this would shift the AD curve to the right thereby increasing the price level.
3.) If the ECB does not start cutting its interest rates soon, the demand for the Euro will increase.
4.) The recession in the U.S. would decrease the global demand, and the global commodity prices would decrease as well. Also, unemployment will increase.
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1. If the US were to cut its interest rates, then other countries will have to match the cut or their currencies will appreciate.
2. Lower interest rates mean an increase in investment and consumer spending which means a rightward shift of the AD curve and an increase in price levels.
3. The value of the Euro will increase, demand for the Euro will increase
4. A US recession could mean a decrese in global demand and therefore prices which will lead to an increase in unemployment.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, then the value of the currencies will increase, meaning it would now cost more for foreign goods in america, and im sure the countries wouldn't want that to happen.
If consumption goes up, this means that AD will shift out, thereby bring the price level up, unemplyment down and real GDP up.
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The US interest rate cut will have to be matched by other countries if a tie in their currency to the dollar is hoped to be achieved. Just like as mentioned in several posts before mine. Recession occurring in the U.S will only cause a decrease in demand therefore increasing the unemployment rate.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, those countries’ currencies would appreciate in value.
Lower interest rates stimulates more investment in the world, causing AD to causing aggregate shift out, increasing the PL.
If the ECB does not start cutting interest rates, the currency will appreciate the demand for Euros will go up.
With the U.S. entering a recession, this pushes demand for goods and services down, unemployment would rise and excess capacity would also increase.
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Rising US interest rates will cause the price level of US goods to be higher relatively in foreign countries. This will result in less demand for American goods around the world. This effect shifts AD back in and decreases GDP and will in turn increase the unemployment rate.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, then those countries' currency will rise in value. Lower world interest rates are considered inflationary because with the increased spending that comes with them and increases GDP, prices are increased. The value of the Euro if the ECB does not start cutting interest rates soon will end up increasing as it is demanded by more people. And a US recession might counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations because it will weaken the global economy's demand for goods and services and increase unemployment.
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What would happen if instead of countries pegging their currency to the dollar, they switch to the Euro? Would the US dollar stop having so much of an effect on foreign currencies?
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If the US interest rate cut is not matched by countires that tie their currency to the dollar, the value of those coutries' currencies will appreciate. The value would go up.
There would be an increase in price level because of the outward shift of AD. There is an outward shift because lower interest rates equal to more investment and consumption.
The demand for euros will increase because the value of it would appreciate if the ECB does not start cutting interest rates.
There will be an increase in unemployment when US is in recession because the demand for their goods and services globally will decrease.
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Meanwhile i read that the interest rate will be lowered, which in turn means that the AD will be increased and PL will go up. THis said, i think this could possibly lead to a global inflation due to the anture that many governements are backed byt he dollar and 45% of all of the U.S. currency is held outside the united states, many people will be very angry with this rise in inflation. Also many governments and organizations have bought bonds from America which will now be worth less, therefore they will also be hurt.
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As everyone has already mentioned, not matching the US interest cut will lead to appreciation of other currencies. The interesting question here is that of how US recession counters inflationary pressures. This relates a lot to the other article posted about how the economies are somewhat balancing. Although this combats inflation, a US recession, as stated still lowers demand. To other nations who export to the US, this is not a good sign.
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1. The value of their currencies would rise because one dollar would be worth much less than one of whatever other currency it was compared to.
2. It leads to an increase in the money supply, with less of the money being consumed due to interest. This increase in the money supply will mean more money per-person, per-business, and per-government, meaning each part of currency is worth less. This is inflation.
3. The value of the Euro will appreciate sharply. It will be more expensive to buy these, compared to the dollar.
4. This is because a recession would indicate that the value of currency has suddenly deflated quickly. Money would be lost through this part of the cycle and U.S. currency depreciation would no longer be a major problem. People within the U.S. would be grasping for money, hoping to get something. Prices would rise and consumers/businesses would be out-of-luck. The foreign nations wouldn’t have to worry about Americans wanting to buy domestic goods.
Trevor Tezel
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Hansen,
As you mentioned, a U.S. recession is not at all a good thing for the foreign countries. Even though the inflationary concerns disappear, both economies are still intertwined. Domestic businesses closing will hurt foreigners who buy those goods. And U.S. consumers feeling more of a pinch on their pocketbooks will be less likely to go out and buy more of any good, whether they are from foreign or domestic companies. For those economic optimists out there, though, this is a way of seeing the glass as being half-full and not half-empty.
Trevor Tezel
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1.Those currencies will appreciate in comparison to the dollar.
2.Lower interest rates make it easier for people and firms to get loans. This increases the money supply, causing inflation.
3.If interest rates are higher in the EU than other countries, investors will convert their money into euros and invest them in European banks to get higher returns. This will increase the demand for euros, causing their value to appreciate. This could make European exports seem more expensive.
4.During a recession, consumer demand decreases as people lose their jobs. This causes a decrease in aggregate demand, which decreases prices. This will counter the inflation caused by loose monetary policy.
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Trevor,
I'm not sure about your answer to the fourth question. I don't think it has as much to do with the value of the currency as basic macroeconomic forces. In a recession, aggregate demand decreases, which causes a decrease in prices. This counteracts inflationary forces. Prices won't typically rise in a recession, because nobody has any money.
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1. If the US were to cut its interest rates, then other countries will have to match the cut or their currencies will appreciate.
2. Lower interest rates would mean increase investment and consumer spending. In turn, this would shift the AD curve to the right thereby increasing the price level.
3. If the ECB does not start cutting interest rates, the currency will appreciate the demand for Euros will go up.
4. This is because a recession would indicate that the value of currency has suddenly deflated quickly. Money would be lost through this part of the cycle and U.S. currency depreciation would no longer be a major problem. People within the U.S. would be grasping for money, hoping to get something. Prices would rise and consumers/businesses would be out-of-luck. The foreign nations wouldn’t have to worry about Americans wanting to buy domestic goods.
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Hansen,
As you mentioned, a U.S. recession is not necessarily a good thing for the foreign countries. Even though the inflationary concerns disappear, both economies are still involved with each other. Domestic businesses closing will hurt foreigners who buy those goods. And U.S. consumers with less income will be less likely to go out and buy more of any good, whether they are from foreign or domestic companies.
Sara
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1. If the US cuts its interest rates, then currencies pegged to the dollar will increase in value.
2. Lower interest rates are inflationary. This is because when they are enacted, the supply of money increases. As everyone has more money, it is worth less and so prices rise.
3. If the ECB does not start cutting interest rates then the Euro will increase in value. This will mean that outside countries want to invest in the Eurozone, which could decrease demand for European exports.
4. A recession in the US would stop most inflationary pressure nationally and abroad. As we know from the Phillips Curve, there is an inverse relationship between inflation and unemployment. In a recession, aggregate demand will fall (becase people don't have money to spend anymore) so aggregate supply will rise. In an effort to sell some of their goods, firms will drop their prices, which will lower the national price level.
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Mollie,
I agree that it's true that governments often only seem interested in short-run solutions and end up making choices that can seriously harm economies in the long run. I think that it's more than just politicians trying to look good, though. The economic long run can be…long. It's hard for politicians to make policy that will look disastrous now even if it might be good for a country in thirty years. In the United States, a presidential term is only four years, so even if a president enacted a more long-run focused policy on his or her first day in office, it wouldn't have time to take effect. It's even harder for voters to pay for these policies, especially when they know that it could easily lead to worsened economic situations for them. Also, economics is a game of assumptions. A lot of the time whole chapters in our textbooks start out, "assuming there are only two countries in the world, assuming those countries trade only two goods, and assuming that there are no transportation costs…" While this is great for learning theory, it's not the way that the world works. Solely long-term policies also don't account for "revolutions"–think of the industrial revolution or the skyrocketing popularity of the personal computer. These have fundamentally changed the way economics works. So, in short, you make a great point and I share your frustration, but I think that because politics is by nature so much more results-oriented than economics we will need to accept that we will often get ineffective policies in the short run.
Thanks for the great post,
Chamonix
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If a US interest rate cut is not matched by other countries, then investors will flock to the country with the higher interest rate. As the value of the money increases small difference of even a hundredth of a percent can mean millions of dollars. This means that the demand for whatever currency is used in the nation with the higher interest rate is increased. This then means the currency appreciates (at least in a floating point system.)
Lower interest rates are inflationary because they lead to the depreciation of a currency, in much the same way that higher interest rates lead to appreciation. In short money is re-invested in other nations with higher interest rates, increasing the supply as well as decreasing demand of whatever currency the nation with the lowest rate has. Thus inflation and depreciation of currency go hand in hand.
If the ECB does not cut the interest rates soon, what will likely happen is that the Euro will appreciate in value as more and more investors transfer their wealth to banks that utilize Euros. This will increase the demand for the Euro and therefore help it appreciate against other world currencies. As the United States in particular right now has a low interest rate it will be especially noticeable in terms of appreciation versus the dollar.
A US recession could counter the inflationary pressure caused by rising food and energy prices and loose monetary policy throughout the United States and the world because it would result in deflation as prices for everything decrease to attempt to win back what little business still exists. What currency is left would appreciate quickly, even if interest rates are cut.
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Charmonix:
It’s interesting that you mention the Phillips curve. That’s a rather concise way of stating something that I think most people would agree with, yet by brining that up you also bring up the issue of whether the Phillips curve is actually true. I would argue that it’s not just the Phillips curve but due to specifically business failing. These business attempts to desperately lower prices (demand being driven down the price will have to go down.) These lowered prices effectively constitute an appreciation of currency and thus counter inflationary pressures.
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1. If a country does not match the US interest rate cut, investors will choose to invest money into that partiuclar country. The value of the country will increase and be a huge flow in income.
2. Lower interest rates are inflationary, due to the fact that when money supply printed, there is more supply thus it becomes less, and prices will rise.
3. IF the ECB doesn't reduce the interest rates the currency will appreciate. The Americans wouldn't be pleased, as the value of the dollar would decrease.
4. A US recession and the affects of it, would depend on the scale and what particular area it affects and what it has caused and will cuase in the future.
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1. If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
If US interest rate cut is not matched by countries that tie their currency to the dollar, the value of other countries' currency would appreciate over dollars because global investors who are seeking for returns in their investment would choose greater interest rate. As a result, the export of the foreign country would become less attractive and it would experience a recession domestically.
2. Why are lower world interest rates inflationary?
Lower interest rates worldwide is inflationary because when one country lowers its interest rate, investors would turn to countries with higher interest rate. Thus it would increase the demand for money and create an inflationary pressure on the market.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon
The value of the euro will begin to appreciate if the European Central Bank does not start cutting interests soon because investors will now turn to European nations with higher interest rates to seek returns for their investment. Relatively, the European nations will have a higher interest rate than American dollars.
4. Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
US recession would counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations because it would reduce consumption. As a top consumer of all products from all over the world, many countries are relying too much on their export to US. By reducing the consumption of imports, it would reduce the inflationary pressure on countries worldwide.
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@Elijah and Charmonix
Although concept can be tied into Philip Curve, it is still somewhat irrelevant and distant because it includes a whole new factor in to the equation – unemployment. We're talking about macroeconomics here. However, it does make sense to bring in that topic because governments must make appropriate decisions to balance between inflation and unemployment within their country. Domestic policy has an effect internationally as business is globalized nowadays.
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As the Fed pours more money into our economy, we watch as the Dow seems to slowly rise – or at least not fall so quickly.
As was mentioned in the article, the supply of currency in the US is expanding (due to the Fed’s latest move) and interest rates falling. This move seems a bit backwards to me; if inflation “can be combatted with restrictive monetary policy,” why are we adding more money? To help in the short run, so we don’t plunge further into the abyss? By now, I’m sure all of our Econ teachers have pounded into our heads the principle that if something is good for an economy in the short run, it’s bad for the long run, and vice versa. So my question is, is the government really worried about keeping us afloat or about looking like they’re doing something so that they won’t get criticized further down the road?
Last I checked, if you screw up now, you have to fix it later. So doesn’t it make more sense to just work a bit more slowly and fix things for the long run? In stead of fixing things for now and then refixing them later? And then again later? And so on. You get my point.
Don’t forget about those interest rates – with interest rates falling, fewer nations will want to buy US bonds, which means we’ll be less popular, and ultimately, with less money. A ‘weak’ dollar isn’t all bad; it hurts some, but helps others.
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1)If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
If a US interest rate cut is not matched by countries that tie their currency to the dollar, that kind of money will be more preferable for the ones who invest. The injections for that country will increase so that we can say that flow of income will increase. But that situation will turn into a disadvantage for other countries: their export rates will decrease so that they will end up in a recession.
2)Why are lower world interest rates inflationary?
When the interest rates get lower, demand for money will increase. Therefore all over the world demand pull inflation will be expected.
3)What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
If the ECP does not start cutting the interest rates, the value of Euro will increase, so that the way that investors will change accordingly.
4)Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
Because of rising food and energy prices, US will end up in a recession. Another reason for that recession is the make loose the monetary policy.
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1. The value of those countries' currency will rise.
2.It's because lower interest rates means consumers will be able to purchase more goods and services and this leads to increase in demand. A great shift of curve of demand to the right, increases the price and inflation occurs when consumers are not able to purchase such high price goods and services.
3. Consumers' demand will decrease since goods and services are too high in price and investment will also decrease. Consumption and investment decrease.
4. Since high price of goods will lead to decrease in consumer demand, trade are not balance in the country. Inflation causes the price to increase and money starting to lose its value.
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not only it effects unemployment, but almost the whole country.
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1. If some nations’ interest cut doesn’t match to US interest cut, those nations’ currency will be appreciated because investor will buy that money expecting more benefits from higher interest. As a result, those nations’ export will decrease and import will increase, which will cause recession in long run.
2. It is because lower interest rate causes demand for money with higher interest rate. This excessive demand will cause appreciation of currency due to shift of demand curve, and will cause increase of exchange rate.
3. If EBC doesn’t cut interest rate, the value of Euro will be appreciated due to increase of demand for Euro. People who originally held other currencies will start to buy Euro to invest.
4. US recession will counter the inflationary pressure in other nations because of decrease demand. US is world’s largest economy and biggest trade partner for most of nations. Therefore, recession US will decrease consumer demand in US, which will cause less import. This affect amount of exports in many nations, and by decreasing demand for goods, decrease of export will decrease inflationary pressure.
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@Helen
I think your answer for 4th question is really good. You not only mentioned dropping global commodity prices but also mentioned other factors, such as unemployment, that can further affect economy. I think it is really well organized and brief answer.
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1. If a US interest rate cut is not matched by countries that tie their currency to the dollar, the value of those countries’ currencies will appreciate.
2. Changes in the central bank’s base interest rate can affect the level of AD in the economy. If interest rates are lowered, then aggregate demand will increase. This is because lower interest rates ultimately lower the cost of borrowing and can lead to increases in both consumption and investment.
3. If the ECB does start cutting interest rates soon, then the value of the Euro will appreciate. This is because the demand for the Euro will increase as it is more beneficial to invest or hold money in the Euro currency.
4. If the US falls into the recession, goods and services in the US will become seemingly more expensive, and so consumption and imports will decrease. Since the US is the biggest economy in the world and many countries depend on its imports and exports, the exports of many other countries will decrease. This will in turn decrease inflationary pressure.
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# Suyeon SO
Great work! I agree with your answers to every single question, espeically answers 3 and 4. Many countries depend on the US, therefore decreased imports for them means decreased exports for others. This kind of dependency proves to be both beneficial and harmful to the "clingy" foreign economies.
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1. If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
The value of those currencies relative to the dollar would rise.
2. Why are lower world interest rates inflationary?
Lower interest rates make it easier for people and firms to get loans. This increases spending, which increases demand, which increases the price level, causing inflation.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
It will encourage people to convert their money into and invest in the euro, which could lead to inflation. It would increase the value of the Euro relative to other countries.
4. Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
A recession signifies a decrease in demand. This decrease would lead to a lower price level, countering the inflation.
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@ James
I agree with your answers. Your answer to number 4 is a lot like what has been happening in the past few years.
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1.If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
It will get higher which will make their currency more powerful but also more expensive which will cause a reduction on its exports.
2.Why are lower world interest rates inflationary?
Because it causes other currencies become more expensive which leads to the rise of prices in overall. If US lowers interest rates and Argentina doesn’t it will cause the peso to be more expensive which will cause price of exports to be higher.
3.What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
It could cause Euro become very expensive which will cause a rise in export price which will cause a decrease in GDP, caused by the smaller amount of exports.
4.Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
Demand on certain goods will decrease which will cause the price of food and other goods to lower due to the lower demand of these goods.
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@ Helen
I think your answers are really accurate and I agree with them, I specially liked your answer for question 1 because it is straight to the point.
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1.If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
The value of those countries’ currencies will rise.
2.Why are lower world interest rates inflationary?
Lower world interests rates are inflationary because the demand for money increases due to a decrease in interest rates of a country. This leads a inflationary pressure on the market in that country.
3.What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
The value of Euro will increase if ECB does not start cutting interest rates. If the interest rates of the countries using Euro there will be a demand to Euro and the it could look more expensive than other currency such as dollar.
4.Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
In simple words this situation can be explained as: when there is a recession the inflation will loose power because the aggregate demand will be decreasing due to the increased unemployment. People will demand to the product less and the producers will decrease their price levels to sell their supply and this will something opposite to inflationary pressure.
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To Merve Akp?nar
Mentioning about the demand pull concept in the second question is so clever. On the other hand, I liked the overall answers you explained all in the simplest way which makes it easy to understand.
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1. If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
Their currencies will be appreciated more and the value of currencies will rise.
2. Why are lower world interest rates inflationary?
It is due to against US dollars other currencies will rise in value and eventually the prices in the market will be higher. The US lowering its interest rates will, for example , cause Argentina to have higher value and exchange rate of peso but this will cause the exports to have high prices and it may be negative for their economy as the consumers will not tend towards the higher price of exports. Also US lowering will increase consumption and investment, raise price levels ever higher.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
The value of Euro will be higher because people will find it more probable to invest on euro and therefore demand for euro will rise.
4.Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
The inflationary pressure lead to recession and therefore the economic activities will be lowered; there will be less demand by the consumer so less domestic production and less imports. Since a lot of world countries have US as their medium of export, their rates of exports will fall down too.
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Dear,
I found it so logical and worth to mention the injections into a country and its relation with the currencies. Congrats.
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I liked the way you linked the second question with the demand.
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1.If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
Currency of US will be appreciated as a result the value of the currencies will increase.
2. Why are lower world interest rates inflationary?
Since there is a situation like US dollars vs other currencies, the other currencies will increase.
The US lowering its interest rates will, for example , cause Turkey to have higher value and exchange rate of TRY but this will cause the exports to have high prices and it may be negative for their economy as the consumers will not tend towards the higher price of exports. Also US lowering will increase consumption and investment, raise price levels ever higher.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
The Euro value will increase because consumer would find it more logical to invest.
4.Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
Recession will ocur because of the inflationary pressure, so the economic activities will decrease.
there will be less demand by the consumer so less domestic production and less imports. Since a lot of world countries have US as their medium of export, their rates of exports will fall down too
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
The value of the currency for a country that is tied will the US dollar will appreciate if the US interest rate cut is not matched. This means that investors will buy a lot of money expecting to gain high interest from it.
Why are lower world interest rates inflationary?
With low world interest rates, investors will be constantly seeking to put their money somewhere there is high interest in order to gain more money, so with this, there will be a high demand for money, shifting the demand curve up, and as we have seen in macroeconomics, create inflationary pressure.
What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
The value of the Euro, if interest rates are not cut will appreciate as more and more investors start putting their money in Euro-using banks creating an increase in the value of the Euro.
Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
With a recession in the US, the deflation of prices on many goods can be used to counter the inflationary pressure caused. It could also counter with the radical decrease in consumption.
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@ elijah.echl.f09
Your responses are detailed, but yet clear and simple and helped me understand some of the consequences behind this appreciation of the currency. You explored why and how this comes to place, while keeping it simple. Thanks for clearing things up for me !
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1.Countries which will not match their interest rates to the ones of the dollar when the interest rates in the states decline will experience a higher amount of investments from investors who change their money from dollars to Argentinean pesos looking for higher profits and causing higher demand for pesos followed by higher exchange rates of the dollar/pesos. This will harm Argentinean exporters as their products will become more expensive and will cause unemployment within Argentina,
2.Lower world rates may cause inflation because they are creating pressure on the economy as more money is demanded which causes prices to rise substantially.
3.If the European Central Bank will not start to cut down interest rates soon than The Euro Zone will experience the same difficulties which are explained above related to Argentina.
4.US recession will counter the inflationary pressure in other nations because of decrease demand. US is the world’s largest economy and biggest trade partner for most of nations. Therefore, recession US will decrease consumer demand in US, which will cause less import. This affect amount of exports in many nations, and by decreasing demand for goods, decrease of export will decrease inflationary pressure.
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The analysis regarding the relation between the state of the US recession is very interesting especially bringing up the point of the aggregate demand but the other answers lack support and further explanations.
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-If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
If a US interest rate cut is not matched by countries that tie their currency to the dollar, their value of currencies is going to increase.
-Why are lower world interest rates inflationary?
In the country the interest rates are going to decrease and as a result of this situation people will demand more for money. Because of this situation lower world interests rates are inflationary.
-What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
If the ECB does not start cutting interest rates soon the value of Euro is going to increase. So the value will be higher than the other currencies.
-Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
We can say that unemployment will increase and as a result of this situation AD will decrease. Because the demand decreases people will buy less and the producers will sell less and to sell more producers are going to decrease the prices. We can say that this situation is just the opposite to the inflationary pressure.
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Thanks for the answer to the 2nd question. You have touched good points…
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1. If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
Countries that do not match the US' interest rate cuts will have their currency appreciate in value.
2. Why are lower world interest rates inflationary?
Lower interest rates means more incentive to spend, increasing aggregate demand, further driving prices upwards.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
If the ECB does not start cutting interest rates soon, the value of the Euro will appreciate in value (as the demand for the Euro will increase).
4. Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
A US recession would cause a decrease in global demand, which will cause prices to decrease as well.
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You didn't really answer the question for the 4th question. The US recession would decrease world demand, bringing prices along with it.
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1.The value of the other currencies would increase as the demand for these other currencies increase. This is because the value of US dollars has depreciated therefore holdings of US dollars are sold for other currencies that are appreciating. Other currencies would be appreciating as they face more demand.
2.Lower world interest rates are inflationary because these essentially expand the monetary supply therefore increasing the purchasing power of those holding currency. However, in response, prices rise as more people are able to afford these goods. This would especially be the case if this was done on a global scale.
3.If the ECB does not start to cut interest rates, they will start to face steady deflation as demand increases for the Euro while there is limited supply.
4.As the recession in the United States causes deflation of their currency, this would cause many Americans to import more goods as their currency trades for more overseas. This would result in increased demand for these other goods experiencing rising prices. Adding to this, many countries holding US dollars would probably exchange them for their domestic currencies due to the favourable rate therefore suppressing inflationary pressures.
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@sara.echl.f09
I agree that foreign exporters would be pleased to see deflation in the United States as this could possibly translate into increased demand for their goods. As currency is exchanged into these other currencies, this would result in the slowing of inflation in these currencies. Also, the increase in supply of US dollars due to these currency exchanges would aid in the deflation problem that the US is currently suffering from. This shows the power of the market and its ability to reach an equilibrium.
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As globalization allows investors to risk in other countries, those people would go wherever they can maximize profits. High interest rates are always a good bait that attracts money inflow from investors looking for high returns. If there is an interest rate cut in U.S dollar while other countries remain high interest rate, people would take their money out of America and invest it in other countries instead, leading increase of money demand of those currencies and therefore higher value of those currencies (graphically a rightward shift of demand curve for currency).
This question concerns the relationship between interest rate and aggregate demand. Lower world interest rates imply low return of savings/investment in money and therefore people would take their money out away from banks. The consequent increase of money supply in global market would lead to an excess of money value to the value of actually production. Since more money is used to buy a fixed amount of goods, the prices of goods will be pushed up to meet an equilibrium of demand and supply. Inflation therefore arises.
According to the theory above, there would be increased demand for euro as a result of its relative high interest rate which attracts investors from America to Europe. ECB should start cutting interest rates following the American action otherwise the euro would appreciate against the dollar. But personally I am not sure if the value of euro would be affected much by the dollar depreciation as the euro is another currency system that is quite separate from the dollar?
Rising food and energy prices are caused by rising demand. Recession indicates weak economic performance and low aggregate demand which is able to pull back part of the excessive demand.
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I don't think "deflation" is the correct word to describe the situation in point 3. If there were to be increase demand for the euro, the exchange rate might be pushed up and might lead to an appreciation of the euro against the dollar. Higher currency value might affect European export but considering the trade volume between these two areas, I don't think the appreciation would have such a strong effect as to cause depreciation.
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Hi Huanni,
I am also not sure that when Euro appreciate against Dollar does this mean that it is gaining value against dollar as well like you said. You really made good points about questions.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
Those countries’ currencies value will rise and the currencies will be appreciated more than before.
2. Why are lower world interest rates inflationary?
When the interest rates are lower, the money supply will eventually increase as people will take their money out of the banks and they become more able to spend that money. This increase in aggregate demand will push prices upwards which form an inflationary gap.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
Because of the demand for Euro increase, if the ECB does not start cutting interest rates, Euro will appreciate against dollar.
4. Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
As there is a recession there will be less demand in the market so that this effect will counter the inflationary pressure caused by rising food and energy prices. Because of decrease in demand, low demand will push prices down as well.
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1.If a US interest rate is not matched by countries that their currency to the dollar, the value of those countries’ currencies will increase because their demand will also increase. The value of the other currencies will be more appreciated in the world economy as the US will see its exports fall.
2.Lower world interest rates are inflationary because it will cause people to take money out of bank savings and not put as much money in banks. So, aggregate demand would increase as the money supply will increase. This means that new amounts of consumption and investment will occur, creating inflation as price levels will increase.
3.The value of the Euro will increase if the ECB does not start cutting interest rates soon because the demand for the Euro will increase. An appreciation will occur as the demand for the Euro will increase. More people would demand the Euro as the exchange rate between other currencies and the Euro will increase.
4.A US recession might counter the inflationary pressure caused by the rising food and energy prices and loose monetary policy in the US and other nations because the low purchasing power that consumers have in a depression will decrease the aggregate demand caused in an inflation. A US recession will also decrease the world trade as the exchange rate for other currencies with the US will increase and imports will be more expensive, therefore decreasing demand.
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@ Asucan I like and agree with your answers. I particularly agree with your answer to question #2. As interest rates are lower, people will be less willing to place their money in banks. This will cause their purchasing power to increase. So, the aggregate demand for goods will also increasing, causing price levels to increase to deal with the high levels of demand.
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1.)If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
The value of their currency will rise. Yet, it may turn into something bad for those countries since their export rates will show a fall because the price of those products will increase.
2.)Why are lower world interest rates inflationary?
The reduction in interest rates will cause demand of money to increase; so that world interest rates are inflationary due to a rise in the prices of commodities overall.
3.)What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
If it doesn’t cut interest rates soon, the value of Euro will increase. Plus, the other countries, as the Euro has risen, will be demanded to Euro. Plus, there can be a decrease in GDP due to a rise in export prices.
4.)Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
Simply, there will be a recession in the USA because of the rise in food and energy prices and also the loose monetary policy due to inflationary pressure. Plus, when we look at the world, the countries using USD in their trades, for them, their rate of exports will also decrease.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
If US interest rate cut is not matched by countries that tie their currency to the dollar, the value of the other countries' currencies would rise and have a higher and more demandable value.
Why are lower world interest rates inflationary?
Lower world interest rates can be considered inflationary because there is a higher incentive to spend after interest rates have been lowered because more and more people would feel comfortable borrowing money, leading to a spike in demand of many products and goods, which will result in a parallel spike in prices.
What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
If the ECB does not start cutting interest rates soon, the value of the Euro will increase. Higher rates will peak interest with American and other foreign investors, therefore increasing the value.
Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
A US recession might counter the inflationary pressure caused by rising food and energy proces and loose monetary policy because a recession would decrease the demand for these products.
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I agree with all of your answers and I think its important that you went into detail about each specific topic. One thing I am confused on is the reasoning that the investors want to take advantage of the higher interest rates, and why they would not simply do it themselves.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
The countries who fail to match the lower interest rates will experience an appreciation in their currency limiting their exports.
Why are lower world interest rates inflationary?
Lower world interest rates lead to inflation because lower interest rates lead to an increase in spending. The spending will increase as it becomes easier to borrow money and the opportunity cost of taking money out of the bank decreases. The increased spending increases the overall amount of money on the market increasing the amount on the market causing inflation.
What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
The value of the currency will continue to increase because more people will invest in the Euro. The increased demand will lead to a further increase in the value. The increased value will also lead to fewer exports as European goods become more expensive.
Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
A US recession would reduce the inflation caused by loose monetary policy because the citizens would reduce spending due to the recession. The reduction in spending would negate the rising food and energy prices because of the lower quantity demanded. When there is less spending, there is less demand for the currency decreasing inflation.
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I agree with your answers and found them helpful to my understanding. Your point about how a hundredth of a percent can make a big difference really puts into perspective how much money multinationals and governments are spending.
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*1 ) If the U.S. interest rate cut is not matched by other countries that tie their currency to the dollar, the value of those other countries’ currencies would rise . The reason is that the value of one dolar would be much less than other curriencies.
*2) Lower interest rates will affect the investments and consumer spending(Both will increase). Aggregate also will be affected (shifts to the right) as a result of increasing of price level.
*3) Since the prices of the goods and service’s prices are high, consumers demand and the investment will decrease. The value of Euro will be appreciated due to increase of demand for Euro.
*4) The recession in the U.S. would decrease the global demand, fact of that the commodity prices would decrease as well. In addition to that the unemployment will rise.
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@merve Akp?nar
Your responses are simple and directly were given according to the questions. Moreover, mentioning the demand pull concept is good.
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1. The value of the other countries would most likely rise and become ‘stronger’ as the US dollar is depreciating and becoming ‘weaker’ than it used to be. This is because the lower interest rate makes investment less attractive as the gain is lower from investments. Therefore foreign investors are likely to switch their currencies to others as they can gain more out of the currencies.
2. Lower world interest rates are simply inflationary as the lower the interest rate is, the more attractive investments and spending money will be. Therefore the increased spending/consumption will ultimately lead to an overall increase in price, and thus leading to inflation in the economy.
3. If the ECB does not start cutting interest rates soon, the value of the Euro will keep increasing and hence become stronger. This means that more people will likely to exchange their own currencies to Euros. It would also mean that Euros would be attractive for foreign investment. Due to the appreciation of the Euros, the European economy would face inflation, and or be under inflationary pressure.
4. Recession is a time period where all economic activities and trade are reduced, and therefore would closely represent the opposite economics situation of inflation/inflationary pressure on the economy. Therefore a recession (decline of trade and activities) would cause the aggregate demand of the US economy to fall, which means that real price levels and real output will both fall. As for monetary policies, the US should be adopting appropriate policies that will balance (to a certain extent) the rate of inflation with other factors (ex: unemployment, although they can never be balanced). However during a recession, a tight monetary policy is unnecessary (as generally, all factors are declining/low).
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To: Julian Cuervo
Thank you for clearing the effect of increase/decrease of the interest rate. I guess people are less attracted to invest money when the interest rates are low, which as you said, would mean that people would take money out of their savings either to invest in other currencies or spend it.
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
The currencies of those countries will rise.
2. Why are lower world interest rates inflationary?
When there is a decrease in the interest rate, the supply will increase since people will have more of their money to spend. The aggregate demand will increase and this will lead to an inflationary gap because of the upwards movement of prices.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
Increase in the demand for Euro will make Euro more appreciated than dollar.
4. Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
The demand in the market will be less since there is a recession. Thus, it will counter the inflationary pressure, and the prices will lower as the demand decreases.
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1. If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
If a US interest rate cut is not matched by countries that tie their currency to the dollar, the value of other countries' currency would appreciate over dollars. This is because global investors who are seeking for returns in their investment would choose the greater interest rates. As a result, the export of the foreign countries would become less attractive and they would experience domestic recession.
2. Why are lower world interest rates inflationary?
Lower interest rates worldwide are inflationary because when one country lowers its interest rate, investors would turn to countries with higher interest rate. Thus it would increase the demand for money and create an inflationary pressure on the market.
3. What will happen to the value of the Euro if the ECB does not start cutting interest rates soon
The value of the euro will begin to appreciate if the European Central Bank does not start cutting interests soon because investors will now turn to European nations with higher interest rates to seek returns for their investment. Thus, the European nations will have a higher interest rate than the USA.
4. Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
US recession would counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations because it would reduce consumption. As a top consumer of all products from all over the world, many countries are relying too much on their exports to the US. By reducing the consumption of imports, the inflationary pressure on countries would be reduced.
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Why do the currencies of other countries appreciate if the US cuts interest rates?
Why will the demand in the market be less?
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• If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
Since many country’s currencies are based on the dollar – meaning that the governments want to keep their currency as close to the dollar value as possible – a cut in the interest rates in the United States will appreciate the value of the foreign currencies if they keep their interest rate constant. This is because the foreign interest rates would look more promising to investors. The investors would start to take the money they have invested in American banks and move it to banks in countries which still have a higher relative interest rate. The dollars that they have taken out of the American banks would need to be changed to the foreign currencies thus increasing the demand. Also since their will be less of the foreign currencies in the market, supply will drop. This all leads to an appreciation of the foreign currencies.
• Why are lower world interest rates inflationary?
Lower world interest rates are inflationary because a lower world interest rate would cause fewer returns on government bonds and therefore less money inside the Central Banks and more money in consumer’s pockets. This would cause businesses to increase the price levels thus increasing inflation.
• What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
Currently, the Eurozone has been a very promising place to invest because of its generous interest rates. This investment increases the value of the Euro because there it increases the demand for the Euro and decreases the supply for it. If the European Central Bank does not start cutting the interest rates, the investment will continue to increase because of the greater rate of return. This investment will continue to appreciate the Euro.
• Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
Since around 60% of the world’s economies have ties to the Untied States’, a recession in the United States would affect 60% of the world. The recession in the United States would lower the price levels because business would notice that consumers do not have as much money as before. This would decrease the inflation rate in the United States. This disinflation would also be felt in the other countries that are intertwined with the US economy. This could cause disinflation in the other countries thus counter acting the inflationary pressure caused by the rising food and energy prices and loose monetary policy.
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@tsekine:
I like your answer to the second discussion question. Your response is simple and clear – to the point.
Thanks
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If a US interest rate cut is not matched by countries that tie their currency to the dollar, what would happen to the value of those countries’ currencies?
It would cause their currency to go up, appreciate. This is because the dollar is worth less than the currency of the country.
Why are lower world interest rates inflationary?
Because lower interest rates cause an increase in investment and consumption, meaning that the aggregate demand curve shifts to the right. This shifts indicates a rise in price in the economy, causing inflation.
What will happen to the value of the Euro if the ECB does not start cutting interest rates soon?
It will cause demand for the Euro to increase since there are high interest rates, this causes the euro to go up, appreciate. This will cause exports to become more expensive and thus exports are reduced.
Why might a US recession counter the inflationary pressure caused by rising food and energy prices and loose monetary policy in the US and other nations?
A US recession would cause investment and consumption to decrease. This reduction in spending would to some extent balance prices since it would cause prices to decrease. This would reduce the inflation. The US recession would also affect global trade since so many countries are affected by the US, global trade would decrease since it is more expensive for other countries to trade since their currencies have appreciated.
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Very good answers, and in question four it is really makes me think about how much the US can really affect other countries since around 60% of the world's economies have ties to the US.
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