Macroeconomics: International Finance

In summary, if the U.S government decides to drastically reduce the required liquidity ratio for banks, causing the money supply to skyrocket and interest rates to plunge, this will affect the value of the dollar in terms of other currencies, assuming that all other things remain constant (in both the US and around the world).
  • #1
Bipolarity
776
2
Suppose the U.S government decides to drastically reduce the required liquidity ratio for banks, causing the money supply to skyrocket and interest rates to plunge. How will this affect the value of the dollar in terms of other currencies, assuming that all other things remain constant (in both the US and around the world) ?

My blunt guess is that money supply and strength of currency are inversely proportional, but I would also imagine that speculators can somehow restabilize the value of the currency even if the money supply is changed.

BiP
 
Physics news on Phys.org
  • #2
I'm not sure how can interest rates for US dollar "plunge", when at least formally US dollar o/n LIBOR interest rate is round 0.147%. (Annual barely exceeds 1%)
http://www.homefinance.nl/english/international-interest-rates/libor/libor-interest-rates-usd.asp

Second thing is the extend to which banks would hold anyway higher liquidity ratio than required by regulators. In my country (Poland) such thing happens so I would not consider that as guaranteed way to increase money supply. (sure, presumably in US bank would use that chance but it doesn't mean that it would mean skyrocketing money supply)

On more thing with so low interest rates the limiting factor is the credibility of your counterpart. If you are about to lend someone money and the annual rate is 0,1% you might wonder whether this is worth the risk and it would be better to keep that in your central bank.

Other constant? Should slightly decrease the value of the currency.
 
  • #3
Based on the previous posters comments: I’d worry more about money supply changes due to injections of base money from the federal reserve; then changes due to liquidity ratios. Keep in mind that capital ratios are more likely to constrain the banks then liquidity ratios. You are right that an expansion in the money supply will weaken the currency and it has in terms of such things as, food, commodities, and stocks.

The inflation in the money supply has yet to have a large effect on the CPI because the money is not injected into the economy evenly. People who can borrow cheaper than inflation can essentially make free money by buying commodities and then selling them at inflated prices. It is these people who could be called the early beneficiaries of what some might call counterfeiting.

For the people who are able to borrow cheaper than inflation there is still a high risk of the bubble bursting in commodities like Gold from contractionary forces such as increases in the interest rate shocks. Interest rate risk could be hedged against by shorting bonds.
 
  • #4
The supply of US dollars goes up, and assuming demand for US dollars stays the same, the price for US dollars will drop. The exchange rate will change accordingly.
 
  • #5
olarScientist's response:

Your intuition is correct – there is an inverse relationship between money supply and the strength of a currency. This is because an increase in money supply leads to inflation, which decreases the purchasing power of the currency. In this scenario, the drastic reduction in the required liquidity ratio for banks would lead to a significant increase in the money supply, causing inflation and devaluing the dollar in relation to other currencies.

However, as you mentioned, speculators and market forces can also play a role in stabilizing the value of a currency. If the U.S. government's decision is seen as a temporary measure and not a long-term change in monetary policy, speculators may not react as strongly and the impact on the value of the dollar may not be as severe.

Additionally, the reaction of other countries' central banks and their own monetary policies can also affect the value of the dollar. If other countries respond by increasing their own money supply, the impact on the dollar's value may be mitigated.

Overall, while a drastic reduction in the required liquidity ratio for banks may initially lead to a decrease in the value of the dollar, other factors and market forces can influence the final outcome. It is important for the U.S. government to carefully consider the potential consequences and monitor the situation closely to ensure stability in the international finance market.
 

1. What is the difference between macroeconomics and international finance?

Macroeconomics is the study of the economy as a whole, including factors like inflation, unemployment, and economic growth. International finance, on the other hand, focuses specifically on the interactions between different countries' economies and how they affect each other.

2. How does international trade impact a country's macroeconomy?

International trade can have a significant impact on a country's macroeconomy. It can increase economic growth by expanding markets for goods and services, leading to more employment opportunities and higher incomes. However, it can also increase competition and put pressure on domestic industries, potentially leading to job losses and economic downturns.

3. What is the role of exchange rates in international finance?

Exchange rates play a crucial role in international finance as they determine the value of one currency in relation to another. This affects the cost of goods and services in different countries, as well as the competitiveness of exports and imports. Changes in exchange rates can also affect the flow of capital and investment between countries.

4. How does a country's balance of payments impact its economy?

A country's balance of payments is a record of all the financial transactions between its residents and the rest of the world. It includes trade in goods and services, investment flows, and transfers of money. A positive balance of payments, where a country receives more money than it pays out, can contribute to economic growth, while a negative balance can lead to economic instability.

5. What role do international organizations play in macroeconomics and international finance?

International organizations, such as the World Bank and the International Monetary Fund, play a crucial role in macroeconomics and international finance. They provide financial assistance, policy advice, and technical support to countries, particularly developing ones, to help them manage their economies and address issues like poverty and economic instability. These organizations also facilitate global cooperation and coordination in economic matters.

Similar threads

  • General Discussion
Replies
1
Views
3K
Replies
7
Views
5K
Replies
5
Views
3K
  • General Discussion
3
Replies
73
Views
9K
  • General Discussion
Replies
4
Views
5K
  • General Discussion
Replies
29
Views
4K
  • General Discussion
Replies
29
Views
9K
Replies
3
Views
4K
Replies
16
Views
9K
  • General Discussion
Replies
31
Views
5K
Back
Top