CFA CFA Level 2 A doubt in economics (FX markets) – L2

A doubt in economics (FX markets) – L2

  • Author
    Posts
    • Knath87
      Participant
      Up
      0
      Down

      Hello all.. I have a doubt in the reading in economics on Foreign currency markets. From the International currency markets, we know that the currency with higher level of interest rate should depreciate with time.. Later in the reading it has been mentioned that the an increase in the real rates in an economy will lead to appreciation of the currency.. Given that nominal interest rate increases will the real rate of interest (Fischer condition : nom_int = inflation + real_int), shouldn’t increase in real interest rates and yield (nominal interest) rates have the same effect on the currency of the economy? Please help me with the dilemma

    • vincentt
      Participant
      Up
      4
      Down

      First point is correct as the currency with higher level of I/R should depreciate.

      Second point is correct as well.
      Just an example:
      Restrictive Monetary Policy -> reduces money supply -> I/R would increase -> inflow of capital to the country -> which leads to the currency appreciation.

      Hope that helps.

    • Sophie Macon
      Keymaster
      Up
      2
      Down

      It depends on the freedom of capital movement and the definition of ‘with time’, i.e. what period we’re talking about (short / long term). We’ve discussed this question before with @vincentt at this useful thread about the Mundell-Fleming model.

      In the international currency markets, I’d think that it assumes free, fluid capital movement between countries, therefore in the long run:

      high interest rates –> inflow of capital –> currency appreciation (your second statement) –> fall in exports –> currency depreciation (your first statement)

      The net effect depends on capital mobility.

      I’m not sure how it relates to your comment on Fischer equation. Can you clarify?

    • Knath87
      Participant
      Up
      4
      Down

      Thanks a lot, @vincentt and @sophie..


      @sophie
      – International fischer condition was a discussion in the context of international parity conditions.. The first statement is a result of Covered and uncovered interest rate parity conditions..
      But I think the difference in the term explains the difference in results 🙂
      Thanks a lot..

    • Sophie Macon
      Keymaster
      Up
      3
      Down

      No problem @Knath87! Glad we could help 🙂

Viewing 4 reply threads
  • You must be logged in to reply to this topic.