Question

How does the foreign exchange rate and supply theory affect gdp in relation to trade and government debt?

Answer 1

Effects of foreign exchange rate

• A fluctuation in the balance of payments causes changes in the exchange rate and a change in the exchange rate will cause changes in the balance of payments in a country's economy.
• These changes come into existence in a free or flexible exchange rate system.
• The GDP is not affected in a fixed exchange rate system as the central bank adjusts the currency flows to match the international exchange rates.
• Same thing happens in case of investments or loans too.
• The exchange against dollar will be more relatively for dollars, in terms of foreign exchange which will affect the GDP.
• The exchange rate may not rise if other factors are pushing down the value of dollars so the GDP also starts showing the affects.

Effects of Supply theory

• Nominal GDP tends to rise with the money supply.
• The interest rates in the economy is lowered with an increase in the money supply and this leads to more consumption and lending or borrowing.
• This situation causes increase in the total outpur and spending and finally the GDP.
• The same situation in the long run is much more difficult to predict.
• There is a strong possibility of assets prices to increase like the housing, stocks etc after too much liquidity enters the economy.