Keeping Interest Rates Low by Devaluating the Dollar and Impact to Foreign Exchange Market

Week 7- Low Interest rates, devaluation, inflation and foreign exchange rates
Name
Institution
Date
Consider the Fed’s current efforts to keep interest rates low by devaluating the dollar. How does this play into inflation, and what impact will this have upon the foreign exchange market?

Devaluing the dollar results in a decline in the currency’s value, where exports become cheaper and the imports expensive. This is likely to result in higher inflation if there are increased imports. Currency devaluation occurs in the case when the central banks raise the domestic currency price of the foreign currency, and the devaluation results in expansion of the output and money supply (Krugman, Obstfeld & Melitz, 2013). When the aggregate demand increases because of higher exports, this will increase growth in the GDP and even prices. The devaluation also lowers the relative price of the domestic goods and is associated with higher demand for domestic production. The long run price level increases proportionately to the increase in the exchange rate when there is devaluation, and in the long run the effect of devaluation is neutral be...