With QEs being conducted by European and Asian central banks, explain what effec

Question

With QEs being conducted by European and Asian central banks, explain what effect a U.S. policy of increasing interest rates will have on prices of U.S. stocks and Treasury bonds and the dollar exchange rate with Euro, yen and yuan?

HINTS: Recall the Fisher relationship where (1+i) = (1+r)(1+pe), where i is the nominal interest rate, r is the required real rate of return before taxes, and pe is the expected rate of inflation.) DLF = I + G - T + NX; I = real investment; NX = net exports G - T = the government deficit (excess of government spending over tax revenues). SLF = S + Ms - H; S = private savings; H = desired hoarding Ms = change in the money supply (a Federal Reserve action)

Explanation / Answer

INcreased rate policy adopted by US would make US asstes more atractive to investors. As with higher interest rates, investors will get higher interests. Thus prices of U.S stocks and Treasury bonds will rise.

With increase in demand of investors for US assets more dollar will be demanded by foreign investors as well. To which dollar will appreciate and hence dollar exchange rate with Euro, Yuan and Yen will increase.

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