Tag: appreciation

On 14 December, the US Federal Reserve announced that its 10-person Federal Open Market Committee (FOMC) had unanimously decided to raise the Fed’s benchmark interest rate by 25 basis points to a range of between 0.5% and 0.75%. This is the first rise since this time last year, which was the first rise for nearly 10 years.

The reasons for the rise are two-fold. The first is that the US economy continues to grow quite strongly, with unemployment edging downwards and confidence edging upwards. Although the rate of inflation is currently still below the 2% target, the FOMC expects inflation to rise to the target by 2018, even with the rate rise. As the Fed’s press release states:

Inflation is expected to rise to 2% over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.

The second reason for the rate rise is the possible fiscal policy stance of the new Trump administration. If, as expected, the new president adopts an expansionary fiscal policy, with tax cuts and increased government spending on infrastructure projects, this will stimulate the economy and put upward pressure on inflation. It could also mean that the Fed will raise interest rates again more quickly. Indeed, the FOMC indicated that it expects three rate rises in 2017 rather than the two it predicted in September.

However, just how much and when the Fed will raise interest rates again is highly uncertain. Future monetary policy measures will only become more predictable when Trump’s policies and their likely effects become clearer.


US Federal Reserve raises interest rates and flags quicker pace of tightening in 2017 Independent, Ben Chu (14/12/16)
US Federal Reserve raises interest rates: what happens next? The Telegraph, Szu Ping Chan (15/12/16)
Holiday traditions: The Fed finally manages to lift rates in 2016 The Economist (14/12/16)
US raises key interest rate by 0.25% on strengthening economy BBC News (14/12/16)
Fed Raises Key Interest Rate, Citing Strengthening Economy The New York Times, Binyamin Appelbaum (14/12/16)
US dollar surges to 14-year high as Fed hints at three rate hikes in 2017 The Guardian, Martin Farrer and agencies (15/12/16)


  1. What determines the stance of US monetary policy?
  2. How does fiscal policy impact on market interest rates and monetary policy?
  3. What effect does a rise in interest rates have on exchange rates and the various parts of the balance of payments?
  4. What effect is a rise in US interest rates likely to have on other countries?
  5. What is meant by ‘forward guidance’ in the context of monetary policy? What are the benefits of providing forward guidance?
  6. What were the likely effects on the US stock market of the announcement by the FOMC?
  7. Following the FOMC announcement, two-year US Treasury bond yields rose to 1.231%, the highest since August 2009. Explain why.
  8. For what reason does the FOMC believe that the US economy is already expanding at roughly the maximum sustainable pace?

Are emerging markets about to experience a credit crunch? Slowing growth in China and other emerging market economies (EMEs) does not bode well. Nor does the prospect of rising interest rates in the USA and the resulting increase in the costs of servicing the high levels of dollar-denominated debt in many such countries.

According to the Bank for International Settlements (BIS) (see also), the stock of dollar-denominated debt in emerging market economies has doubled since 2009 and this makes them vulnerable to tighter US monetary policy.

Weaker financial market conditions combined with an increased sensitivity to US rates may heighten the risk of negative spillovers to EMEs when US policy is normalised. …

Despite low interest rates, rising debt levels have pushed debt service ratios for households and firms above their long-run averages, particularly since 2013, signalling increased risks of financial crises in EMEs.

But there is another perspective. Many emerging economies are pursuing looser monetary policy and this, combined with tighter US monetary policy, is causing their exchange rates against the dollar to depreciate, thereby increasing their export competitiveness. At the same time, more rapid growth in the USA and some EU countries, should also help to stimulate demand for their exports.

Also, in recent years there has been a large growth in trade between emerging economies – so-called ‘South–South trade’. Exports from developing countries to other developing countries has grown from 38% of developing countries’ exports in 1995 to over 52% in 2015. With technological catch-up taking place in many of these economies and with lower labour and land costs, their prospects look bright for economic growth over the longer term.

These two different perspectives are taken in the following two articles from the Telegraph. The first looks at the BIS’s analysis of growing debt and the possibility of a credit crunch. The second, while acknowledging the current weakness of many emerging economies, looks at the prospects for improving growth over the coming years.


‘Uneasy’ market calm masks debt timebomb, BIS warns The Telegraph, Szu Ping Chan (6/12/15)
Why emerging markets will rise from gloom to boom The Telegraph, Liam Halligan (5/12/15)


  1. How does an improving US economy impact on emerging market economies?
  2. Will the impact of US monetary policy on exchange rates be adverse or advantageous for emerging market economies?
  3. What forms does dollar-denominated debt take in emerging economies?
  4. Why has south–south trade grown in recent years? Is it consistent with the law of comparative advantage?
  5. Why is growth likely to be higher in emerging economies than in developed economies in the coming years?

On August 11th, China devalued its currency, the yuan, by 1.9%. The next day it devalued it by a further 1.6% and on the next day by a further 1.1%. Even though the total devaluation was relatively small, especially given a much bigger revaluation over the previous three years (see chart below), traders in world markets greeted the news with considerable pessimism. Stock markets around the world fell. For example, the US Dow Jones was down by 1.1%, the FTSE 100 was down by 2.5% and the German DAX by 5.8%.

There are three major concerns of investors about the devaluation. The first is that a weaker yuan will make other countries’ exports more expensive in China, thereby making it harder to export to China. At the same time Chinese imports into the rest of the world will be cheaper, thereby making it harder for domestic producers to compete with Chinese imports.

The second is that cheaper Chinese imports will put downward pressure on prices at a time when inflation rates in the major economies are already below target rates. The fear of deflation has not gone away and this further deflationary twist will intensify such fears and possibly dampen demand.

The third is that the devaluation is taken as a sign that the Chinese authorities are worried about a slowing Chinese economy and are using the devaluation to boost Chinese exports. The rapidly expanding Chinese economy has been one of the major motors of the global economy in recent years and hence a slowing Chinese economy is cause for serious concern at a time when the global economy is still only very slowly recovering from the shock of the financial crisis of 2007–8

But just how worried should the rest of the world be about the falling yuan? And will it continue to fall, or could this be seen as a ‘one-off’ correction? What effect will it have on the macroeconomic policies of the USA, the eurozone and other major countries/regions? The following articles analyse Chinese policy towards its currency and the implications for the rest of the world.

China weakens yuan for a third straight day on Thursday CNBC, Nyshka Chandran (13/8/15)
Markets reel as investors fear worst of Chinese slowdown is yet to come The Telegraph, Peter Spence (12/8/15)
China cannot risk the global chaos of currency devaluation The Telegraph, Ambrose Evans-Pritchard (12/8/15)
Beware a China crisis that could crash down on us all The Telegraph, Liam Halligan (15/8/15)
The curious case of China’s currency The Economist, Buttonwood’s notebook (11/8/15)
China’s yuan currency falls for a second day BBC News (12/8/15)
China slowdown forces devaluation BBC News, Robert Peston (11/8/15)
What the yuan devaluation means around the world BBC News, Lerato Mbele, Daniel Gallas and Yogita Limaye (12/8/15)
China allows yuan currency to drop for third day BBC News, various reporters (13/8/15)
The Guardian view on global currencies: it’s the economy, stupid The Guardian, Editorial (14/8/15)
China’s currency gambit and Labour’s debate about quantitative easing: old and new ways to cope with economic crisis The Guardian, Paul Mason (16/8/15)


  1. By what percentages have the nominal and real yuan exchange rate indices appreciated since the beginning of 2011? Use data from the Bank for International Settlements.
  2. Explain the difference between nominal and real exchange rate indices.
  3. Compare the changes in the yuan exchange rate indices with that of the yuan/dollar exchange rate (see Bank of England Interactive Database). Explain the difference.
  4. How is the yuan exchange rate with other currencies determined?
  5. How have the Chinese authorities engineered a devaluation of the yuan? To what extent could it be described as a ‘depreciation’ rather than a ‘devaluation’?
  6. Why have world stock markets reacted so negatively to the devaluation?
  7. Why, in global terms, is the devaluation described as deflationary?
  8. How much should the rest of the world be worried by the devaluation of the yuan?
  9. Explain the statement by Robert Peston that ‘Beijing has done the monetary tightening that arguably the US economy needs’.
  10. Comment on the following statement by Stephen King of HSBC (see the second Telegraph article below): ‘The world economy is sailing across the ocean without any lifeboats to use in case of emergency.’