Question

A. Currently the US economy has improved considerably. Is a strong dollar good or bad for the economy? Explain?

B. Currently inflation is very low in the US when compared to countries such as Brazil, Russia, India or China. Do you expect the dollar to appreciate or depreciate versus these currencies. Explain.

Answer 1

A) A strong dollar is a good sign for the economy. A strong dollars indicate that Dollar has apreciated its value against other currency. US can imports goods at cheaper price with the strengthen Dollar. Let say a Goods X cost 10,000 EURO and Exchange rate is 1.4 Dollars per Euro. Hence it means that we need $14,000 to import such goods and if the Dollar strengthen against euro and let say the exchange rate is 1.2 Dollars per Euro then we can import the same goods at only $12,000. Also a strong dollar will increase the demand of Dollars in foreign market. Goods will get cheaper and imports too and hence a strong dollar is good for economy.

B) As per PPP(Purchasing power parity) theory basically states that a unit of currency should have the same ability to purchase something from country to country.Inflation distorts this parity so whenever the model comes out of sync between two countries, the exchange rate between the two countries should adjust to allow equilibrium to return. Inflation is having an inverse relationship with currency price. If the Inflation increases the price of the currency will depreciate against other contries and if the Inflation is low then the price will appreciate against other currencies.

Currently the Inflation is very low in US as compared with other countries like Brazil, Russia, India or China and hence the Dollar will seem to appreciate aginst these countires curruncies.