December 22, 2020

Fiscal and monetary policies have an impact on a country’s exchange rate, terms of trade and economic performance .the economy’s performance. As we have noted the difference between the nominal and real exchange rate is nothing more than the ratio of the two economies price level . The small difference between the two series indicates to us that the bulk of the fluctuations in the exchange rate are the result of fluctuations in the real rates of return differential across the economies. The data suggests that monetary policy differences, the ratio of the CPI’s accounts for a small fraction of the fluctuations in the nominal exchange rate. If adjustment is costly the economic response to the change in policies will gradual . Which means that some of the changes we will be seeing on key economic indicators will be due , in part, to the response and adjustment to previous policies and economic shocks. Identifying the adjustment trends may provide us with a reasonable picture of what to expect in the near and medium term. Over the near term we expect the US to outperform the rest of the world. As long as the real exchange rate is above the PPP band, we expected US rate of return to exceed the rest of the world. As the real exchange rate declines so will the excess rate of return. When the real exchange rate enters the PPP band, the US rate of return will approach that of the rest of the world. The policies of Biden administration if unchecked will take us back to the Obama-Biden Administration. Looking back during the Obama years , the real exchange rate remained at the lower end of the PPP band, see Figure 2. If the Biden administration takes beyond the Obama polices , we look for the rela exchange rate to fall below the PPP line.

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