Do lower US american interest rates with higher european rates cause the dollar to be of less value vs. Euro?

Question

Thus if there is more demand for eurpean output on behalf of Americans but less supply on behalf of europeans as a result of the increase in their rates then it means that the dollar has to loose its value so that supply can meat demand?

Is my reasoning correct????

The valuation of currencies is so interesting to me yet I've never had anyone explain it to me accurately...

Id really appreaciate some help to de-mystify it!!!! thanks!!

Answer 1

Currency follows supply/demand just like another item.

If interest rates in the US fall, it means the money supply has increased, which reduces the value of the dollar relative to other currencies.


Your reasoning is kind of correct, only in this case it has little to do with any shift in demand.

Answer 2

You conclusion is correct but your reasoning left out the most important factor. The exchange rate between currencies is determined by both trade flows and investment flows of money. The large trade deficit the US has been running with the rest of the world has been balanced by large flows of investment money into the US. The net inflow and outflow of money always balances.In general trade adjust slowly but financial markets react almost instantaneously, so short and long therm effects may and often do act in different directions. The lower interest rates in the US will lower the returns on US investments will reduce foreign investment and therefore further weaken the dollar. However in the longer term, the weaker dollar will increase exports and decrease imports which will help the US economy. Inflation which may be a product of the rate cut adds even more confusion to the analysis.

Answer 3

So what happens is that by cutting interest rates, the Fed makes it less attractive to invest in the U.S., and so more of the funds available for investment go to where there are higher rates of return. A new equilibrium is reached when enough money has gone into the other investments that the return on them is comparable to the new lower U.S. rates.
So two things happen. When interest rates in one country go down, money flows out of that economy to other economies, and some money that was invested is turned to consumption.
I hope that helps explain things to you, if you have other questions, post them.