- What is really meant by a “strong” dollar?
The price of a currency is determined by supply and demand. For example, if foreigners are very keen to buy US dollars, they will have to pay more of their own currency for a given amount of dollars. The dollar is said to be “strong” when its price in terms of other currencies, known as its exchange rate, remains relatively high over a prolonged period.
- Would there be advantages in having a single currency throughout the world?
Things might be a lot simpler then! But who would be responsible for ensuring that the currency maintained its value? Different currencies can be measured against each other and such competition gives them an opportunity to prove their worth.
- Why is the dollar such an important currency?
The dollar is the currency of the world’s most important economy, the United States. It is used in many other countries as a second currency and also plays an important role in international payments and settlements.
- Wouldn’t it be great if everything kept getting cheaper?
If you knew that something was going to be cheaper tomorrow, you would never buy it today. Continuously falling prices would paralyse the economy. Besides, if prices kept on falling, wages and salaries would also have to fall, creating a spiral in which everyone would lose out. This is what is known as deflation, and central banks need to guard against it just as much as against inflation, which, on the other hand, is characterized by a rise in the general level of prices, leading to less purchasing power for consumers.
- Can the National Bank influence the stock market?
Not directly, and it should not even attempt it. But monetary measures do sometimes have an impact on the stock market because the market reacts – among other influences – to expectations regarding economic trends. If a Central National Bank raises interest rates because of a risk of inflation, economic activity will slow down and the stock market in that country will tend to weaken. On the other hand, low interest rates can stimulate the economy, which often helps to buoy up the stock market.
- Does the economy influence the Central Banks’ policy?
Economic conditions are always changing in ways that hit some sectors harder than others. Thus exporters suffer from a marked appreciation of the currency, whereas the construction industry, for example, remains virtually unaffected. In such a situation the export industry will want monetary policy to be eased. When judging whether or not to change its monetary stance, the Central Banks must consider not only the interests of a single sector, but also the situation of the economy as a whole.
- Why don’t the Central Banks try to keep inflation at zero?
Higher prices are not only caused by inflation. Products and services can become dearer because of quality improvements. But it is not always possible to assess this factor accurately when measuring inflation. This is why an inflation index often records inflation at a somewhat higher level than is actually the case. The Central Banks take account of this fact when it equates “price stability” with an annual inflation rate of less than 2%. If it targeted an inflation rate of 0%, the money supply would usually be too tight.
- Couldn’t the Central Banks simply prevent unemployment?
Unemployment can have various causes. For example, it can be the result of cyclical weakness. In this case the Central Bank will ease monetary policy. This will stimulate demand in the economy at large and help to bring unemployment down again. But when unemployment persists at a high level, the reasons often lie elsewhere, e.g. in an over-regulated labour market. There is nothing that monetary policy can do in this situation. Instead, changes to the law are needed to encourage job creation.
- Does the Fed Reserve Board coordinate its monetary policy with foreign central banks?
The Fed lays down its monetary policy with reference to conditions in the US. On the other hand, the US economy is very much dependent on developments abroad. The Fed therefore needs to know what foreign central banks are thinking and doing. Such knowledge is imparted through the regular exchange of information between the US Fed and foreign central banks.
- Do all countries pursue a similar monetary policy?
Today most countries aim at price stability and try to create conditions that allow their economies to achieve balanced growth. The idea, once held, that the economy could be encouraged to keep on growing through the pursuit of a very liberal money supply policy without this leading to inflation has now been abandoned. However, although a marked convergence of monetary policy objectives has taken place, differences in practice persist.
» Become a member of the All Things Forex community