Federal Reserve & Stength of the Dollar

The purpose of this research is to review the role of the Federal Reserve in the recent strength of the dollar in international currency exchange. For purposes of this research, the dollar's currency exchange value against the Japanese yen and against a tradeweighted basket of currencies will be used for comparisons.

RECENT MOVEMENTS IN THE VALUE OF THE DOLLAR

On 5 December 1989, the value of the dollar against the yen closed at Y143.80:$1 ("Markets Diary," 1989). This rate compared to a high over the past 12 months of Y149.46:$1, and a 12 month low of Y121.92:$1. The Federal Reserve has recently moved gradually to relax shortterm interest rates (Randall, 1989). The prime motive of the Federal Reserve action is to provide moderate stimulation to a softening economy. The action, however, also tends to weaken international demand for the dollar, which, in turn, leads to a decline in the international currency exchange value of the dollar.

EXPLAINING THE CHANGING VALUE OF THE DOLLAR

In the early1970s, as a consequence of the declining value of the dollar in international currency exchange markets,

1 2and a continuing and increasing drain on the country's monetary gold supply, President Nixon devalued the dollar, which, in turn, increased the conversion value of gold. When this actionfailed to either stop the fall in the value of the dollar, or the drain on the country's gold stock, the president established a twotiered gold price s

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d on a contention that relative rates of inflation determine longrange exchange rate changes (Hooper, and Morton, 1982). It is assumed that exchange rates adjust in a way which insures that, subsequent to conversion into another currency, a currency in question will purchase goods and services in a foreign country equivalent to that which it could purchase in the domestic economy (Burtle, 1984). It is also assumed that exchange rates will fluxuate with respect to relative rates of price inflation between countries (Humpage, and Karamouzis, 1986), and that shifts in trading patterns will cause changes in the relative 5rates of inflation between countries, which will, in turn, maintain a longterm equlibrium in currency values. The interest rate principle assumes that the real rate of return on assets will be equal. It also assumes that the real rate of return will be independent of the currency denomination of the asset. The logic of the Fisher condition is that "the nominal rate is formed by lenders as the sum of the real rate plus whatever inflation is expected to be over the course of the lending period" (Ekelund, and Hebert, 1983, 454). When the Fisher effect is applied to the international currency market, the impl

Category: Economics - F