1. This question is based on the article, "How America's blockbuster stimulus affects the dollar," published by The Economist on March 13, 2021. The article discusses the drivers of the past and potential future trends in the value of the dollar in terms of other currencies. Note that the article mentions changes in "risk appetite" as a driver of exchange rates. By "risk appetite" the article means willingness to hold riskier currencies as opposed to the U.S. dollar, which is considered the safest currency. So, when risk appetite declines, people prefer to hold more dollars and demand higher premia for holding risky currencies. [26 points total for Question 11]

(a)According to the article, how did risk appetite change in March 2020 and how did it affect the dollar's value in terms of other currencies? [6]

Answer:

(b)According to the article, how did the actions of the Fed help with the situation described in (a)? How did the risk appetite change in the rest of 2020 and how did it affect the dollar's value in terms of other currencies? [6]

Answer:

(c)The article claims that "the greenback's bounce-back this year is more about interest-rate differentials." Based on the evidence and arguments presented in the article, does the appreciation of the dollar between mid-December 2020 and mid-March 2021 seem to be due to changes in short-term interest rate differentials that already took place or expected changes to interest rate differentials in the future? [6]

Answer:

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(d)At the time of its publication in mid-March, the article predicted that the dollar seemed "likely to rise a bit further in the near term." That prediction has not proven quite correct (see https://fred.stlouisfed.org/series/DTWEXBGS, which shows that the dollar has weakened between mid-March and mid-May 2021). However, it points out that "later in the year, though, there is a case for a mildly weaker dollar, which better matches the recent trend in the value of the dollar vis--vis other currencies. What is the article's reasoning for this prediction? [8]