Foreign Exchange Rates and Quantitative Easing: Impact on Global Economy

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Contents
Question 1...................................................................................................................................................4
1.1 Foreign Exchange Rate.......................................................................................................................4
1.1.1 Demand Side of a currency.........................................................................................................6
1.1.2 The Supply side of Currency........................................................................................................6
1.2 Foreign Exchange, Supply of Currency and Interest Rates.................................................................6
1.2.1 Foreign Exchange Markets and Interest Rates: The Role of Quantitative Easing........................7
1.3 The Global Financial Crisis and the US Quantitative Easing...............................................................8
1.4 Quantitative Easing by Federal Reserve Bank of USA: The Impact on China.....................................8
1.4.1 Background: The Chinese Practice of Devalued Currency...........................................................8
1.4.2 Quantitative Easing between 2008 and 2013.............................................................................9
1.4.3 Trade...........................................................................................................................................9
1.4.4 US Dollar and Dollar Backed Securities Portfolio of China........................................................11
Question2..................................................................................................................................................13
2. Currency Devaluation........................................................................................................................14
2.2 Fiscal Stimulus.................................................................................................................................15
2.3 Monetary Policy...............................................................................................................................16
References.................................................................................................................................................18
Graph 1 Real GDP of USA dropped sharply due to the Global Financial Crisis.............................................8
Graph 2 US Imports from China since 1985.................................................................................................9
Graph 3 Dollar Index Weighted For Trade.................................................................................................10
Graph 4 Short Term Interest Rates for USA...............................................................................................11
Graph 5 Long Term Interest Rates of USA.................................................................................................12
Graph 6 REER for US Dollar . Source (The World Bank, 2018)...................................................................15
Graph 7 Budget Deficit of USA since 2007.................................................................................................16
Figure 1 Supply and Demand Model of Currency and it's Price in the Forex Market..................................4
Figure 2 Increased Supply due to lower Interest Rates (Samuelson & Nordhaus, 2006).............................6
Figure 3 Aggregate Demand Shifts Rightward due to expansion...............................................................14

Figure 4 The Impact of Lower Interest Rate on Investment and GDP.......................................................17

Question 1
1.1 Foreign Exchange Rate
Like Most markets, the Foreign exchange market rates differ from week to
week and month to month. This is due to the fact that, hypothetically,
Foreign Exchange rates are determined by supply and demand (assuming
there is no government intervention).(Samuelson & Nordhaus, 2006)
The Foreign exchange Market is the worldwide market in which different
currencies are traded and foreign exchange rates are determined.
(Cherunilam, 2005)
Foreign currencies are traded , in the retail level in many banks and firms
specializing in the business. Organized markets or exchanges in prominent
cities like New York, Tokyo, London trade billions of dollars each day.
(Samuelson & Nordhaus, 2006)
A typical supply demand curve can be used to illustrate how markets
determine the price of foreign currencies.(Cherunilam, 2005)
In the figure given below, the supply and demand for US Dollars that arise in
dealing with the currencies of other countries. In the given example, the
Yuan, which is the most basic unit of Remnibi is used to illustrate the supply
and demand.(Samuelson & Nordhaus, 2006)

Figure 1 Supply and Demand Model of Currency and it's Price in the Forex Market
Source:(Samuelson & Nordhaus, 2006)
The supply of US Dollars comes from people in the USA who need the Yuan
(or Remnibi) to purchase Chinese goods, services and other financial assets
such as bonds etc. The demand for Dollars comes from people in China who
buy US goods , services or financial assets. The Foreign Exchange rates or
the price of a dollar or a Yuan settles at the intersection of supply and
demand. At a Foreign exchange market, different currencies are traded.
Thus, the prices are determined by which currencies are mostly being
supplied or given up and which currencies are being demanded or bought.
(Samuelson & Nordhaus, 2006)

In the diagram above , the Foreign Exchange Rate it at price “p” which
corresponds the equilibrium between supply and demand of the US Dollar in
the international currency markets.
1.1.1 Demand Side of a currency
The demand of the US Dollar to the market originates when the foreign
consumers need the US dollar to buy goods. However, it is not just
consumers but also, banks, investors etc. demand the US currency.
Additional demand for US Dollars also, arises when China based investors
(including Central Bank) which to purchase financial assets in USA etc. The
demand curve for a currency slopes downwards and this indicates that as
the US Dollar falls (and the Yuan becomes) more expensive, the residents of
China will want to buy more of US goods, services and Assets.(Samuelson &
Nordhaus, 2006) .
1.1.2 The Supply side of Currency
The supply of the US Dollar has been represented in the upward sloping SS
curve. The supply of the US dollar to a foreign exchange market originates
when Americans need to buy Yuan (or any foreign currency to purchase any
good).(Samuelson & Nordhaus, 2006)
It is important here to understand that, in reality, the supply of currency is
not a bilateral exchange. (Samuelson & Nordhaus, 2006) Samsung is a brand
from South Korea and may produce goods in China. In order to service orders
purchased in the USA, the Chinese unit of Samsung may either accept US
Dollars or Yuan or the South Korean Won. Samsung may prefer to hold US
Dollars for a variety of reasons.
1.2 Foreign Exchange, Supply of Currency and Interest Rates
The simple, demand and supply excludes one aspect though. It is, not
necessary that the amount of Dollars bought by a Chinese consumer will go
into the Foreign Exchange Reserves of China. (Samuelson & Nordhaus, 2006)