The economic theory of law of one price states that when you look at the same basket of goods in two different countries the values of both baskets should theoretically be the same. This is because we can assume that in two complete markets the exchange rate will move toward an equilibrium rate that equalizes the value of both baskets of goods in the long run. Therefore, the implied exchange rate between two burgers should be the same as the actual exchange rate. But it all relies on the Purchasing Power Parity (PPP) theory. For example, considering two countries with different disposable incomes; The Economist invented the so-called Big Mac index which is based on hamburger prices. All you have to do is figure out the prices of a Big Mac in different currencies. Theoretically, all those prices should be the same as they are in the US after you’ve converted them to dollars. Assuming that a currency is at its correct level, could it still be that one burger will be more expensive than the other? Of course, it all depends on the purchasing power in a given country; and this involves expenses and income. The higher the income, the higher the prices.
Purchasing Power Parity (PPP) theory claims that the exchange rate between currencies of two country’s should be equal to the ratio of the country’s price levels. Also, as the purchasing power of a currency sharply declines (due to hyperinflation), that currency will depreciate against stable currencies. The theory explains how exchange rates move and adjust to make goods and services cost the same everywhere and thus it is an application of the law of one price in reference to a national price level. If a rise in the nominal interest rate in the U.S is accompanied by an equal rise in the U.S inflation rate, the real interest rate remains constant. In this case, higher nominal rate do not make dollars denominated securities more attractive to U.K investors because the rising U.S inflation will surely discourage U.S investors to seek outlowered priced U.K goods that will probably increase the demand for pounds and cause the U.S dollars to depreciate. The only scenario where this will not be the case is if there is higher nominal interest rates in the U.S which signals an increase in the real interest rate. This will then make the dollar rate to appreciate. Also, if there is a signal of a rising inflationary expectations and a falling real rate, the dollar will depreciate. Technical Analysis deals with the use of historical exchange rate data to estimate future and values. The technical approach is use to estimates past exchange rates and then projects them into the future to generates forecasts, while ignoring economics and political determinants of exchange rate movements.For example, you want to know the exchange value on a currency, the technical analysis will help you to look for price trends on that currency and you can then use the chart to determine the economics fundamentals. If the exchange rate move substantially above or below the trend lines, it might signal that a trend is changing which could help you determine whether to buy or sell the currency in the foreign market. Fundamental Analysis is the opposite of technical analysis as it involves the consideration of economic variable that are likely to affect the supply and demand of a currency and it’s exchange value. It uses computer based econometric models that are statistical estimations of economic theories to predict and generate forecast. For example, it gives you an idea of the idea of the types of variables you might need to include in your econometric model to determine whether a currency is over or undervalued in a longer term sense. The Exchange Rate Adjustments and Balance of Payments for the exchange rate adjuctments and balance of payments illustration, it talked about J-Curve Effect in the short-term of a currency depreciation which will lead to a worsening of the nation's trade balance, but as time passes, the trade balance will likely improve. As exchange rates pass through the extent to which changing currency values lead to changes in import and export prices. According to the monetary approach to currency depreciation, the currency depreciation may induce a temporary improvement in a nation’s balance-of-payments position. Currency depreciation (devaluation) may affect a nation's trade position through its impact on relative prices, incomes, and the purchasing power of money balances. Manufacturers often obtain inputs from abroad (foreign sourcing) whose costs are denominated in terms of a foreign currency. As foreign currency-denominated costs become a larger portion of a producer's total costs, an appreciation of the domestic currency exchange value leads to a smaller increase in the foreign currency cost of the firm's output and a larger decrease in the domestic cost of the firm's output compared to the cost changes that occur when all input costs are denominated in the domestic currency, the opposite applies for currency depreciation. Therefore, export cheapens and a devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports. Also, after a devaluation, a country’s assets become more attractive; for example, a devaluation in the Pound can make UK property appear cheaper to foreigners. Bassically, the article explains how things did not seem to turn out how it was like according to economic theory that says the economy will boost with growth if the policies reduce interest rates and increases domestic investment and consumption spending, thereby stimulating output and unemployment. Attempting to stabilize both the domestic economy and the dollar’s exchange value can be difficult for the Federal Reserve. But Expansionary monetary policy will come in place when central bank uses its tools to stimulate the economy. That increases the money supply, lowers interest rates, and increases aggregate demand. It boosts growth as measured by gross domestic product. Actually, it usually lowers the value of the currency, thereby decreasing the exchange rate. It is also the opposite of contractionary monetary policy. Expansionary monetary policy deters the contractionary phase of the business cycle. Therefore, it could be helpful in coordinating private sector expectations which could be interpreted as a rationale for intervention as a longer term management tool. But it is difficult for policymakers to catch this in time. As a result, you typically see expansionary policy used after a recession has started. In order to cope with the global financial crisis, the U.S and other countries have tried in an attempt to control the contagion and minimize losses to the society, restore confidence in the financial institutions and instruments, and to lubricate the wheels of the economy in order for it to return to full operations. To achieve this goals, the top countries have tried to implement some means for other countries to have sufficient funds through international Monetary Fund, World Bank, and capital surplus nations such as loans to help all countries with insufficient sources of capital.
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