It is important to note that foreign exchange dynamics and their associated rates are determined by a multitude of factors, which encompass various economic, political, and social aspects of nations. The most fundamental drivers of exchange rates come from the supply and demand for a particular currency, and the difference between the nations results in such rate changes. Behind these forces, there are influences, such as economic growth, inflation rates, and interest rates. The given analysis focuses on assessing a study of the United States’ international trade dynamics with both developed, such as Canada, and developing nations, such as Mexico.
It should be stated that foreign exchange rate values can be the result of both domestic alterations as well as international elements. A study suggests that “in response to a U.S. monetary tightening, GDP in foreign economies drops about as much as it does in the United States, with a larger decline in emerging economies than in advanced economies” (Iacoviello & Navarro, 2018, p. 232). In other words, the foreign exchange rate affects the international trade of the United States with Mexico more heavily than the former’s trade with Canada. Although both Canada and Mexico deploy floating exchange rate regimes, the factors of interests and trade openness alongside demand and supply directly impact the overall trade with Mexico more severely. The given effect establishes and explains why many emerging nations are more likely to adopt fixed or pegged float exchange rate regimes. The reason is to be able to manage and control major spikes or drastic changes without affecting the population. Therefore, policy decisions made by the United States as well as international trade policies play a critical role in regulating and controlling the vulnerabilities between trading nations, such as Canada and Mexico.
The article is tightly related to the course concepts covered since it illustrates the preference of one regime over another when it comes to exchange rate settings and to trade with the world’s largest economy. The presented evidence suggests that “in advanced economies, trade openness with the United States and the exchange rate regime account for a large portion of the contraction in activity. In emerging economies, the responses do not depend on the exchange rate regime or trade openness, but are larger when vulnerability is high” (Iacoviello & Navarro, 2018, p. 232). In terms of inflation, as a general rule, a country with a consistently low inflation rate will see a currency rise in value as its purchasing power increases relative to other currencies. During the second half of the 20th century, countries with low inflation included Japan, Germany, and Switzerland, while the US and Canada reached low inflation later (Iacoviello & Navarro, 2018). Countries with higher inflation tend to see their currencies depreciate against the currencies of their trading partners. It is important to understand that this is also generally accompanied by higher interest rates.
In conclusion, foreign exchange rates are determined by a large number of factors that affect the demand and supply of a currency. These forces can include inflation, interests, economic growth, trade relations, and currency rate regimes. The international trade between the United States and other countries, such as Canada or Mexico, can also be affected by the type of economy. Emerging nations are more vulnerable to losses, whereas developed countries are more resilient to serious fluctuations.
Reference
Iacoviello, M., & Navarro, G. (2018). Foreign effects of higher U.S. interest rates. Journal of International Money and Finance, 95, 232-250. Web.