Question

4. Refer to the Economist article (you can find this on D2L under "Resources") titled "Dethroning the dollar: The search to finding an alternative to the dollar." a. Interpret the last sentence in the below paragraph using the model of exchange rate determination in chapter 14. (5 marks) "A world in which the dollar is tested from several sides will be unpredictable. In the longer term, more balance among global reserve currencies may make the global monetary system less vulnerable to shock. And the dollar's current pre- eminence is not an unalloyed good for America: it distorts the currency's value (upwards) and market interest rates (downwards)." b. Although the article states that the dollar is not currently under threat by the efforts of several countries to protect their interests, suppose that a concentrated effort to dump U.S dollars in foreign markets was successful. What would be the impact on the U.S interest rate and the U.S dollar? (5 marks)

Answer 1

a. Part a explains that dollar being hot favourite for investors all over the world and also looked as the safer avenue to invest may not be well for stability of world economy.

It was evident in 2008 financial crisis as USA had slowdown and then recessionary impact spread all over the world. It would be better if other currencies become stronger and this will lead to better competition among countries on more competitive heads like research and development and new product-new market development.

There will be less scope for speculation then. Dollar follows free floating exchange rate. Dollar value is determined by market forces. When demand shifts right then dollar appreciated. Less stability leads to appreciation of dollar as demand for dollar shifts to right citing safer investment in it.

b. As dollar will be demanded less then its value will go down and it will depreciate. USA interest rates will go up to attract new investments from all over the word.