Explore BrainMass

Explore BrainMass

    Economic Relationship: The U.S Dollar

    Not what you're looking for? Search our solutions OR ask your own Custom question.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    While nations of the world had previously tied their currencies to the gold standard, that practice abandoned in favor of linking currencies directly through floating exchange rates. Due to the dominance of the United States in economic and financial matters, the US dollar became the "reserve currency" of the world. Other countries tied their exchange rates to the dollar.
    1. What responsibilities did that impose on the US? What were the risks to other nations?
    2. Explain the relationship between the inflation rates in two countries and their exchange rates.

    © BrainMass Inc. brainmass.com October 4, 2022, 1:47 pm ad1c9bdddf

    SOLUTION This solution is FREE courtesy of BrainMass!

    1. Responsibilities on the US
    Due to linking of other currencies with the US dollar, it imposes responsibility on the US that Federal Reserve monetary policy is made with the consideration of the global economy rather than the US only. It is because the Federal Reserve monetary policy has a significant influence on the foreign exchange value of the dollar. It is also the responsibility of the US to maintain fixed exchange rates, so that the growth of the other economies could be protected (Ravenhill, 2011). At the same time, it is also a major responsibility of the US for having the dollar as the dominant currency in the market to support the global financial markets by issuing the government debts to foreign countries continuously by honoring the interest payments over the existing debts.

    Risk for Other Nations:
    The dominant position of the dollar in the international currency market also creates risk for other nations as any change in the policy of the US also brings changes in the economic planning of other nations and influences their growth (Reinert, et.al, 2010). The recent US shutdown affected the various economies due to change in exchange value, which influenced the investment and saving activities in the economies that linked their currency with the US dollar. At the same time, change in Federal Reserve monetary policy in favour of the US influences the growth of other countries as it increases the exchange rate, which reduces the value of their linked currency (The Conversation, 2013).

    2. Relationship B/W Inflation and Exchange Rates of Two Countries
    An increase in the inflation rate of one country causes a decline in the spot exchange rate of that country. It increases the purchasing power of another currency, which has less inflation than the first country. It depicts that if two counties have different inflation rates then the relative price of a good in those countries will be different (Madura, 2012). It is because country with higher inflation will have less currency value in the comparison of the country that have lower inflation rate.

    The current rate of one country will change in the relation of another country's currency because of the difference in the inflation rates of these two countries. Thus, there is a significant relationship between the inflation rates in two countries and their exchange rates. This link is related with Purchasing Power Parity (PPP) theory, which is focused on the relationship between differential inflation rate and foreign exchange rate movements (Siddaiah, 2010).

    Madura, J. (2012). International Financial Management (11th ed.). USA: Cengage Learning.
    Ravenhill, J. (2011). Global Political Economy. UK: Oxford University Press.
    Reinert, K.A., Rajan, R.S., Glass, A.J. & Davis, L.S. (2010). The Princeton Encyclopedia of the World Economy. New Jersey: Princeton University Press.
    Siddaiah, T. (2010). International Financial Management. USA: Pearson Education Inc.
    The Conversation. (2013). US shutdown opens the way for China in global currency markets. Retrieved from: https://theconversation.com/us-shutdown-opens-the-way-for-china-in-global-currency-markets-19054

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    © BrainMass Inc. brainmass.com October 4, 2022, 1:47 pm ad1c9bdddf>