Can anybody explain why expansionary fiscal policy increases real interest rates leading to currency appreciation?
Expansionary fiscal policy is essentially what the democrats are pretty much known for. Not to get too political but essentially they want to decrease taxes, and increase spending. Well how well they get this money you ask? They borrow, and by borrowing they essentially run up the interest rates. Look at Greece who has borrowed more money than god, and their interest rates show it. This increase in interest rates will cause outside capital to come in and cause the currency to appreciate.
It’s kind of counterintutive since the exports will be going down, while imports will be going up, but the interest rate appreciation trumps it in this instance. Someone correct me if I’m wrong please, Econ was never my best subject.
When there is an expansionary fiscal policy the government either lowers taxes or increases their spending. The theoretical consequence is increased deficits. Increased deficits will lead to more borrowing which will lead to higher real interest rates. Higher real interest rates will increase the DEMAND for the domestic currency thus leading to currency appreciation.
rseth +1
also note that while spending and rates are going up, so is inflation which puts downward pressure on the currency. however the effect of increased demand for the currency more than offsets the inflationary pressure so the currency appreciates.
Isn’t anybody finding that this conclusion of expansionary fiscal policy which raises interests and so the currency price does contradict the fact of covered or uncovered parity??
Can somebody explain why the parity doesn’t prevent the domestic currency from appreciating?
Thanks
Interest rate parity doesn’t attempt to predict future exchange rates, so it has nothing to do with currency appreciation or depreciation.
Never has, never will.
That’s not its job.