Exchange Rates and Interest Rates: Global Competitiveness

Introduction

The purpose of this essay is to discuss and understand the role of exchange rates and interest rates. The essay focuses on how these two principles are related and how they simultaneously affect the development and manifestation of one another's essence. This essay also addresses how the competitiveness of a nation depends on these financial rates functioning in harmonious balance.

Defining Competitiveness

In the corporate model, profits rely on competition to provide exchanges of energy—or money. Money drives economic activity, and the quest for its power puts humanity and its organizational capabilities in motion in attempts to gain an advantage. Competition, like all concepts and ideas, is merely a tool and model that can guide leaders of corporations and countries toward performing honest and truthful acts that reflect a higher standard of living.

Competition without sportsmanship, however, provides breeding ground for the worst of humanity, seen in greed and ruthless devastation of other people and property in varying forms of conflict. Nations and organizations alike should strive to balance competition with ethical aims and principles. This balance is essential for sustainable economic and social progress.

Exchange Rates and Interest Rates

The exchange rate and interest rate of any given country can have varying and changing effects depending on circumstances relevant at the time. Since the exchange rate is a measure of the strength of a currency in relation to another, subjective opinion plays a large role in the exchange rates offered by currency traders seeking competitive advantage. Traders often manipulate financial markets to make profits through the mere exchange of money, without any true value of products or services changing hands. Commerce has been modified to include the exchange of money based on future events that relate to the originating source of a nation's currency.

The role of inflation is pivotal in determining how exchange rates and interest rates correlate with one another. Inflation ultimately dictates the strength of a nation's currency and hence its competitiveness. As Hakkio (1996) explains, "One simple channel linking interest rates and exchange rates is through the effects of inflation. Since nominal interest rates depend on expected inflation while nominal exchange rates depend on relative rates of foreign and domestic inflation, an inflation shock will affect both nominal interest rates and exchange rates."

The Mysterious Nature of Economic Relationships

Millions upon millions of factors, numbers, contributions, and ideas go into any economic forecast. A nation's ability to be competitive within the global marketplace must be aligned with their strategic goals and outcomes. The goals and objectives a nation sets for itself largely dictate how competition unfolds. The stage is not equal in the global market, making it very difficult to suggest that a clear and definitive relationship can be established between competition, exchange rates, and interest rates. Their confluence suggests that something transcending economics and finance itself is at work.

Hnatkovska et al. (2008) agreed that this relationship is mysterious in nature and provides only a glimpse at what may be inferred from financial data. They argued that "What is the relationship between interest rates and the exchange rate? The empirical literature in this area has been inconclusive. The relationship between interest rates and the exchange rate is non-monotonic. In particular, the exchange rate response depends on the size of the interest rate increase and on the initial level of the interest rate."