Approach – unusual movements in the exchange rate

Assessing the health of an economy is always a complex task, since there are many indicators to consider and their interpretation requires different economic theories and models. In the face of so much complexity, people tend To select a variable that acts as a thermometerbeing the exchange rate one of the most common.

In our country, the economic crisis of 2003 was accompanied by a strong currency devaluation that led to the emergence of a Significant increase in the cost of family basketWhile the Dominican peso recovered against the dollar during the recovery period in 2004-05 and prices stabilized. From then on, it is interpreted that the economy is strong if it remains stable or if the exchange rate rises, and in the face of any sign of Currency devaluation revives old fears of the past.

However, judging the state of the economy by the exchange rate can be misleading. In the 1980s and 1990s, the Chinese yuan was constantly declining, while the Chinese economy experienced years of unprecedented dynamism. The exact opposite happened in Japan, where the Japanese yen gradually gained value against the dollar, but the Japanese economy entered the nineties in a painful recession.

In the case of North America, in both the economic crisis of the early 1980s and the Great Recession of 2008-2009, the dollar rose strongly against most world currencies. So it’s only natural to wonder, What determines the depreciation or appreciation of a currency? To better understand the answer, it is important to remember that the exchange rate is the price of one currency against another, and that all prices are a consequence The interaction between supply and demand.

Various factors can change the supply and demand for foreign exchange, with the interest rate always being the most important. Which is that when a country raises the interest rate more than the rest of the world, it makes investing in its currency more profitable, so many local and international investors go to buy the currency of the country that raised its price recently, they invest their money in financial instruments in that currency and enjoy a higher return.

An example of this is the US dollar, which has risen in recent days very dramatically Reached parity with the euro. Since the birth of the euro at the beginning of the twenty-first century, it took about 1.1-1.6 dollars to buy the euro, but in recent days, the dollar and the euro are equal in value.

This is explained by the successive rate increases made by the US Federal Reserve during the first six months of the year, but also because it announced that it would continue to raise interest rates during 2022 and 2023. On the contrary, the European Central Bank did not make any hike For interest rates, he was not willing to make significant increases in the near future.

Given this situation, it is not only normal for the dollar to reach parity with the euro, but it can be expected That the US currency continues to rise in the coming months. Something similar happened in our country, where the Dominican Central Bank has been in a race to raise interest rates since November last year, to the point that the 3-year investment vehicles issued by the Central Bank in November 2021 had a return of 4.8%, and those issued in February 2022 had 8.5% return. That is, in only 4 months interest rate on these tools nearly doubled. As a result, the peso appreciated by 5% at the beginning of the year, which is unusual in the dynamics of the Dominican stock exchange. Regarding the future perspective, it is expected that the Dominican Central Bank will continue to make significant adjustments in the interest rate, thus achieving greater profitability in investments in peso compared to investments in dollars, which is expected to remain stable in the Dominican peso, or even continue to appreciate.

This estimate is not a reflection of the strength or weakness of the Dominican economy, it is simply the natural result of an increase in interest rates. Looking ahead, we must get used to the fact that the dollar sometimes rises and sometimes falls, and exchange rate movements should not be seen as a sign of anxiety or confidence in the future.

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