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Why has the price of the dollar been falling with respect to other currencies, such as the Euro and the Pound?

My econ professor was explaining the market for foreign currency exchange, and he implied that when a country is running a budget deficit (like the US) the price of its money would rise (the demand for dollars being downward sloping, with exchange rate in the y-axis and net exports in the x-axis, and the supply of dollars being fixed i.e. a vertical line). He said that the increase in government spending would cause the supply of dollars in the market to fall, which in turn would cause the exchange rate to rise (with the vertical supply line shifting to the left, intersecting the demand curve at a higher point). If this is the case, then why is the price of the dollar falling? Asked by studentkkg, 649 days ago

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ANSWERS (1)

Jon Jacobs, Information Services, 642 days ago

The value of a nation's currency is determined by a number of factors, including trade flows, monetary policy, fiscal policy, and perceptions of political risk, among others. It's true, as you stated, that expansionary fiscal policy (i.e. budget deficits) can sometimes bolster a nation's currency (although even this isn't so simple, because if a government is thought to be spending and borrowing more than it should, foreign lenders may lose confidence in its currency). The driving forces behind the U.S. dollar's recent movements, however, have been chronic payments deficits - we're massively exporting dollars to Asia and elsewhere, as Americans buy more of their goods and services than we sell to them - and loose monetary policy (i.e. a fast-growing global supply of dollars engineered by the Fed to help keep the economy out of recession). The mortgage/credit/bank crisis is negative for the dollar as well, since at the margin it makes foreign investors less inclined to buy U.S. (i.e., dollar-denominated) financial assets.

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