1 Simple View of Exchange Rate Determination

2 EUR exchange rate against the dollar: EUR value in USD

3 Source: FRB, NY

4 The ForEx market  Supply of the USD  Imports to the US  Goods (trade)  Services (tourism)  US investment abroad  Foreign Financial Markets  Direct investment abroad  Central Banks  Speculation  Demand for the USD  US Exports  Goods  Services (tourism)  Foreign Investment into US  US Financial markets  Direct investment  Central Banks  Speculation

5 The Interesting 90’s  : Collapse of the USSR Block, beginning of the Transitional Recession in Eastern Europe  1994 Mexican Currency Crisis  1991(2)-95 The Balkan Wars  1998 Recession in Japan  1997 (July) Beginning of the Asian Financial Crisis  1998 major Rouble Crisis US ECONOMY average % rates Real GDP Gross Domestic Private Investment Non-Residential Investment9.10.2

6 The market for USD in the 90’s DS Influx of investment stimulated Demand Increase in imports stimulated Supply Demand Effect Dominated (thus positively effecting consumers’ standard of living) P of USD

7 The post 90’s era  United Europe  10 New Countries Entered the Union on May 1 st of 2004, bringing the total number of member states to 25, with combined population of over 430 million (US population is 293 million).  Growth in Russia and China nearing double digits  Emerging Economies of Brazil and India  Threat of Terrorism to the US  Continuous Growth in US Trade Deficit

8 Should We Be Concerned With The Fluctuating Dollar?  TRADE and Currency Fluctuations  Price Changes  Standard of Living  Commodity Prices DateUSD per EUROUSD Price of OILEuro Price of OIL March 1, March 3, March 1, March 1, % change over the period

9 Can the Government Influence the Value of the Dollar?  Monetary Policy  Changes in Interest Rate and Investment Flow  Fiscal Policy  Borrowing leading to changes in Interest Rate

10 Currency Trade and Exchange Regime Floating Exchange Rate Regime  Currency Trade by Central Banks Fixed Exchange Rate Regime  Does Recent Dollar Depreciation Impact the Trade Deficit with CHINA?  Price Stabilization and Fixed Exchange Rate Regime  Risk to CB

11 The BIG picture  Rise in Imports  Increase in Supply  Depreciation  Rise in Exports  Increase in Demand  Appreciation  Influx of Investment  Increase in Demand  Appreciation  Outflow of Investment  Increase in Supply  Depreciation  BALANCE OF PAYMENTS – An Economy’s International Balance Sheet (

12 Balance of Payments  Current Account  Trade  Income flow  Financial Account  Investment Flow Paying for Foreign Goods with Domestic Financial Assets – the US Example (US BoP)