Forex Trading: Studying Fundamental Analysis Part 2

By in Intro to Forex on December 25, 2019

Inflation and the interest rate

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At last, we have approached to consideration of a question of interrelation of inflation and the interest rate. For the further reasonings it is necessary to make small deviation.

In the economic theory it is accepted to divide all variables on two groups. The first is constituted by nominal variables, that is the size measured in monetary units, and the second – real variables – the size measured in physical units. Using such classification it is possible to conduct distinction between the real and nominal interest rate. Earlier we determined an actual interest rate, as nominal (bank) behind inflation minus. Now it is possible to explain these concepts

The nominal interest rate is a nominal variable as serves as a measure of the income which can be received on some amount of money, having enclosed it, say, in bank. The actual interest rate is a real variable as it displays a ratio of real cost of assets in the present and the future adjusted for inflation.

Importance of such approach consists in that the long-term period a state credit policy (i.e. reduction or increase in the offer of money) influences only nominal sizes, and real remain without changes. To explain such conclusion it is possible using an example.

Let’s admit, the official length of meter has changed with 100 to 50 centimeters. All distances in this case will nominally be doubled, and actually remain the same. Money inherently is a measure of value, also as meter of a linear measure.

Let’s answer a question what will occur to the nominal interest rate at price level growth? It is obvious that to interest people to do savings, and, simply speaking, to borrow money to banks, the state or other people in the same volume, as earlier, the nominal interest rate should be increased and, at least so, to cover losses of the population from inflation. It concerns, both bank interest rates, and Central Bank discount rate. It is proportionally accepted to name dependence at which, the offer of money from the Central Bank, inflation rates and the nominal rate of percent increase Fisher’s effect.

And now let’s collect all acquired information with the help of familiar model.

So, the state has increased the offer of money. It has found display in strengthening of inflationary tendencies both corresponding growth of a price level and decrease in value of money. The nominal interest rate reacts not at once to acceleration (delay) of inflationary tendencies. I.e. in the short-term period we receive both decrease in pure export, and actual interest rate decrease.

The last finds display in growth of pure foreign investments and still bigger nominal exchange rate decrease, in comparison with a base situation (I suggest to consider this process on schedules independently). After a while the Central Bank raises discount rate taking into account the increased rate of inflation (proportional growth of the nominal interest rate), and the real rate comes back to initial level. Pure foreign investments again decrease, and the nominal exchange rate increases a little, but there is not enough to block the previous decrease.

Thus, it is possible to draw conclusions. Inflation acceleration in the long-term period should lead to decrease in a nominal rate of native currency. But this decrease occurs as though in two stages: at first the decrease more essential, than decrease in a ratio external and internal prices, and then some correction connected with growth of the nominal interest rate (discount rate increase) correction. For this reason, large speculators change rates of inflation and connect them with possible changes of discount rates in advance to occupy correct (long or short) long-term position or to specify the future basic direction of a trend.

People who took the decision to participate in forex trading must start from learning the basics of currency exchange market to make sure you do not have problems with this industry.

There is another option – you can hire experienced traders to managed your trading account – read more about forex investment here. Also make sure to look for the info in a good forex book.

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