Macroeconomics Assignment: International Finance and Exchange Rates

This macroeconomics assignment solution analyzes exchange rate determination using the uncovered interest parity (UIP) model. It explores how high capital mobility affects interest rates and currency values in different countries, examining the persistent higher interest rates in developing economies compared to developed ones. The assignment then delves into how countries pegging their currencies to the US dollar, like Hong Kong, import US monetary policy. It further investigates the impact of the Singapore dollar's (SGD) appreciation and subsequent depreciation against the US dollar, considering the effects on interest rates. Finally, the solution examines the consequences of tight monetary policy in the US on emerging market currencies, such as those of India, Brazil, Indonesia, and Argentina, and their depreciation pressures.

Running head: MACROECONOMICS
MACROECONOMICS
Name of Student:
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Table of Contents
Answer to Question: 1.....................................................................................................................2
Answer to Question: 2.....................................................................................................................2
Answer to Question: 3.....................................................................................................................3
Answer to Question: 4.....................................................................................................................4
Reference List..................................................................................................................................5

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Answer to Question: 1
Higher capital mobility allows the developing countries to attract foreign direct
investment into the home country at a high rate. This creates greater amount of investment
opportunities in foreign countries. When capital goods are mobile, the difference in real
exchange rate will go down. Even though developed economy will be flooded by capital inflow,
it will not strengthen the currency value of developed country this inflow creates greater job
opportunities and increases the aggregate level of income (Ghosh, Ostry and Chamon 2016).
Uncovered Interest Rate Parity (UIP) defines that the difference between the interest rates
of two countries will be similar to the relative change in currency foreign exchange rates over the
same period because rise in FDI raises the demand of receiving country’s currency which
increases its exchange rate. This values improves the terms of trade with respect to price of
export to import. Capital mobility drives out the differences between exchange rates without
causing much currency devaluations.
Answer to Question: 2
Monetary policy is the policy used to manage the money supply and interest rate to attain
stable macroeconomic objectives like consumption, inflation, liquidity and growth. Dollar peg is
the value of currency at fixed exchange rate with respect to the US dollar. A fixed amount of
currency is given in exchange of US dollar. Central bank buy the US treasuries to generate
interest from dollar holdings. This happens only when a country has huge amounts of exports in
United States and receives dollar payments (Kearns and Patel 2016).
Central bank estimates the currency exchange rate and maintain the currency value by
lowering dollar’s value and raising the currency value when the value of currency falls below

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peg. This is done by selling treasuries in the secondary market such which enables bank to buy
the local currency (Loaiza Maya et al. 2015). With addition of treasury supply leads to a fall in
dollar value that helps to maintain a stable price level. Moreover, keeping similar currency level
is not easy as dollar value fluctuates on a constant basis. Pegging helps to protect currency value
with stable price that does not hamper business development. This is similar to monetary policy
which maintains the money supply in order to balance the inflation and interest rates. This
influences the aggregate demand by affecting exports, imports, debt cost and employment.
Answer to Question: 3
Currencies depreciate due to several factors that affect trade and development such as
political instability, economic fundamentals and interest rate differentials. When the value of a
currency depreciates means that the value of currency has weakened in correspondence to
another currency. An appreciation of US dollar means that it has gained the value of other
currencies. However, appreciation of Singapore dollar in 1980 against the US dollar means that
imports from United States are cheaper (Gabaix and Maggiori 2015). When the value
depreciated by 10 in July, 2014 it meant that Singapore’s currency has been 10 times more
stronger than its previous position such that domestic goods are cheaper which leads to a rise in
net export.
A further depreciation of 14 percent in 2016 suggests the fact that Singapore currency has
become much stronger than dollar value that makes import costly and export cheaper. A rise in
domestic consumption leads to a rise in price level due to greater demand (Ahmed, Appendino
and Ruta 2015). In order to tackle inflation, inflation rates are raised in Singapore that will lower
aggregate expenditure. On the contrary, interest rates in US will go down due to appreciation. An
appreciation of dollar value means that the value of domestic goods will increase with respect to

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foreign goods, making imports cheaper. A lower interest rate will not allow inflow of capital or
attract foreign firms. Thus, lower interest rates will attract increase expenditure on domestic
goods and bonds.
Answer to Question: 4
Tight monetary policy is adopted to slowdown the economic growth as a result of high
consumer spending. This is done by raising the interest rate which lowers money supply in the
economy. Depreciation of emerging markets like India, Brazil, Indonesia, Argentina etcetera
suggests that the currency values of these economies are becoming stronger in comparison to US
which makes domestic goods inexpensive (Verdelhan 2018). People from the emerging
economies will heavily depend on domestic goods instead of importing products. As a result, the
value of net export will fall severely in US because growth of US is fueled by the growth of
these sectors. That is why interest rates are increased that will lower consumer expenditure and
profit level. This will attract foreign direct investment of US to the developing countries which
will further enhance the profitability and balance the exchange rates. This will generate higher
yield value for the investors with a stronger rate of exchange in favor of US dollar.

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Reference List
Ahmed, S., Appendino, M. and Ruta, M., 2015. Depreciations without exports? Global value
chains and the exchange rate elasticity of exports. The World Bank.
Gabaix, X. and Maggiori, M., 2015. International liquidity and exchange rate dynamics. The
Quarterly Journal of Economics, 130(3), pp.1369-1420.
Ghosh, A.R., Ostry, J.D. and Chamon, M., 2016. Two targets, two instruments: Monetary and
exchange rate policies in emerging market economies. Journal of International Money and
Finance, 60, pp.172-196.
Kearns, J. and Patel, N., 2016. Does the financial channel of exchange rates offset the trade
channel?. BIS Quarterly Review December.
Loaiza Maya, R.A., Gomez‐Gonzalez, J.E. and Melo Velandia, L.F., 2015. Latin American
exchange rate dependencies: A regular vine copula approach. Contemporary Economic
Policy, 33(3), pp.535-549.
Verdelhan, A., 2018. The share of systematic variation in bilateral exchange rates. The Journal
of Finance, 73(1), pp.375-418.