Question

In a monetary policy move at the end of 2016, the U.S Federal Reserve Bank, the country’s central bank raised interest rate citing a stronger economic growth and rising employment. Here in Asia, currencies have generally been weakening against the US dollar as money has flown out of Asia and into the dollar.

Sources: BBC News, 15 & 16 December 2018

a) How have the Asian countries been affected by the increase in the U.S. interest rates?

b) In the absence of government intervention in Asian countries to the increase in U.S. interest rates, identify and explain two possible beneficial and two non-beneficial effects on the economy.

Answer 1

(a) The Asia countries will witness a capital flight as investors withdraw money from these countries and invest it in the US which is now providing a higher rate of interest. This will increase the demand for dollar in the international currency market and te Asian currencies will depreciate.

(b) Beneficial effects are:

(1) Since the Asian currencies will depreciate, their competitiveness will improve and these countries will see a rise in exports.

(2) Currency depreciation can lead to a boost in tourism in Asian economies. as the value of the dollar is higher and a lot of people in the US might use this opportunity to plan a cheaper vacation

Non-beneficial effects are:

(1) If a country is a major importer, then currency depreciation can hurt the country as the cost of its imports will rise. The trade deficit might actually increase.

(2) A decline in capital flows can hurt the productive activity in the country especially if there is excess capacity. Without any investment to operate in, many firms can go out fo business and the economic growth may suffer.