A study of the macroeconomics involved in FX rates and the effect of the financial crisis on the relationship

Abstract

This report aims to discuss the currency markets in the current scenario. We first discuss the different kinds of players involved in the currency market and their varied roles which are crucial to the system in its entirety. We then discuss how the size of the market has grown over the years and the changing mix of currencies being traded in the world market. We then discuss the macroeconomic effect that the financial crisis has had on the world economy. There has been an increase in the debts that nations are carrying. Budget deficits are at an all-time high. Emerging economies on the other hand are fighting a battle of their own. They want to keep their currencies undervalued to keep exports competitive. In the process they have built huge reserves of US Dollars and have started what is being called a currency war. We then talk about the impossible trinity in the currency markets and how economies attempt to defy and perform on the face of a global competition to grow and survive. We discuss the Bretton Woods regime and how a new monetary system is evolving. US and China are the two biggest economies and undoubtedly will be the most influential economies in the coming decade. But if the world’s biggest economy stagnates and the second-biggest keeps its currency cheap and its capital account closed, a rigid monetary system will eventually buckle. On a different note then, we discuss the kinds of factors that affect the value of a currency pair. We discuss these factors in detail. Then we pick up 4 most traded currencies and conduct a critical analysis of the factors affecting them before and after the financial crisis. We analyse if these factors have come to pre-crisis levels.