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Rakhi Vasavada
Rakhi Vasavada, Financial and Legal Consultant
Category: Finance
Satisfied Customers: 4545
Experience:  Graduated in law with Emphasis on Finance and have have been working in financial sector for over 12 Years
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I have a finance/economics question I was hoping you could

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I have a finance/economics question I was hoping you could help me with. It's not related to law so I apologize. I have heard people on the radio say that the strength of the dollar rises with inflation (higher interest rates I presume as well). How is this possible if inflation erodes the value of the dollar?

Also during inflation, or deflation, how does it affect the US dollar index? I know the us dollar index is a measure of the US dollar against other currencies, but I don't know what makes the index go up or down. Thank you!

rakhivasavada :

Dear Friend,

Hello and welcome. Thank you for using Just Answer.

This question is little broad in nature. Let me try and throw some light on this.

rakhivasavada :

Yes, what you heard on radio is primarily correct. However, it is also important to note that merely inflation does not drive the value of the dollar up or down. There are many factors responsible for it.

rakhivasavada :

For example, it is important what action does the Government take through it monetary policies during an inflation that will affect the value of the dollar. For example, during inflation, when the value of the goods and services are rising, other people will chase the dollar. For example -- "if French investors saw an opportunity in the U.S., they might be willing to pay more francs in order to get dollars to invest in the U.S." More francs per dollar means the dollar’s value has risen.

rakhivasavada :

Having said this, on the other hand, if the Government decides to fight inflation, it would raise interest rates through it monetary policy and this try and suppress the demand artificially. Less people would buy goods and chase dollar as the cost of money would become high. This would result into falling in value of dollar due to artificially decreased demand.

rakhivasavada :

So, plainly speaking, during deflation, the value of the dollar falls and it rises during inflation. Now, once this happens, what actions does the Government takes through its monetary policies would drive the value of the Dollar.

rakhivasavada :

Kindly also note that there are number of factors that affect the value of dollar and the dollar index.

Trade factors like Balance of trade,Falling prices on foreign goods, Balance of investment -- Political factors like Budget deficit and national debt, Terrorist attacks and war, Geopolitical events, Elections, Tax cuts for consumers, ---- Other external factors like Turmoil in other countries, Stability in other countries, A change in foreign reserves, A strengthening Euro, --- Other Economic factors like Demand for dollars, Demand for physical currency outside the US, Increase in money supply -- etc -- are some of the many many factors that affect Dollar Index during both inflationary and deflationary times...!

rakhivasavada :

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