Question

Suppose there are two countries that are otherwise the same (e.g. in regards to inflation and risk etc.) except that Country S3 has a strong economy and Country W3 has a weak economy. Suppose one or both of the central banks of S3 or W3 is pursuing a domestic monetary policy such that interest rates do not equalize between the two countries. Which country will tend to have the weaker currency in foreign exchange markets?

Answer 1

Country W3 will have a weak currency in the foriegn exchange markets as if the exonome of a country is weaker it means the country is have very weak growth in its economy and the net exports of the country are also low. If the net exports of the country are low it means that the country have more imports than exports as these country will create demand for import good currency and they are reducing the demand for their own currency due to less exports. Thus weak currency will always be found in country with weak economic conditions and growth rate. So W3 has weak economy and hence its currency has a weak currency in foreign exchange market.