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Suppose there are two countries—the United States and Germany—in a trade agreement. You are analyzing the...

Suppose there are two countries—the United States and Germany—in a trade agreement. You are analyzing the impact of the recession in the United States on the foreign currency market. How would a recession in the United States affect the market equilibrium exchange rate (dollar price of the Deutsche mark) and quantity of the Deutsche mark change? Within your essay, please address the concept below.              

  • What factors shift the supply and the demand curve for foreign currencies?
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Answer #1

There are several factors that affect the exchange rate determination. The exchange rate is determined when the demand and supply of foreign exchange are equal.

During the recession, inflation falls so the interest rate also falls. Fall in interest rate leads to the outflow of capital to new destinations where interest rates are higher. Thus the demand for dollar will fall and it will drag down the interest rate.

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