Question

Explain the contingent story for how the Federal Reserve’s recent increases in U.S. short-term interest rates could lead to either a further rise or a pending fall in the value of the U.S. dollar relative to other global currencies. Give at least two explanations

Answer 1

Federal Reserve is apex monetary institution in USA, based on recent data, US economy has fully recovered from economic crisis and now has reached the level of natural rate of unemployment. Thus, now Fed is focusing upon the stable price level:

• Increase in interest rate in USA by slashing down money supply will invariably cause inflow of fund from elsewhere. Thus, eventually, value of dollar shall rise.
• Second, High interest rate will lead to fall in aggregate demand since now people will not be able to get money easily or cost of borrowing will rise. So import is likely to fall that will result into appreciation of dollar value.