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International Journal of Global Economics and Management
ISSN: 3005-9690 (Print), ISSN: 3005-8090 (Online) | Volume 4, Number 1, Year 2024
DOI: https://doi.org/10.62051/ijgem.v4n1.55
Journal homepage: https://wepub.org/index.php/IJGEM/index
Content from this work may be used under the terms of CC BY-NC 4.0 licence (https://creativecommons.org/licenses/by-nc/4.0/).
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Study on the Correlation Between Exchange Rate Fluctuations
and the Global Economy Based on Macroeconomic Models
Qiantong Meng
Jinan New Channel -JUTES High School, Jinan, China
ABSTRACT
In the context of global economic integration, exchange rates act as a bridge connecting national
economies, and fluctuations in exchange rates directly impact the global economy. An exchange
rate is the ratio at which one currency can be exchanged for another, representing the value of one
country's currency against another's. Additionally, exchange rates serve as a financial tool for
countries to achieve political objectives. This study deeply analyzes the correlation between
exchange rate fluctuations and the global economy based on macroeconomic models and identifies
the multiple factors influencing exchange rate changes. The research finds that exchange rate
fluctuations affect international trade competitiveness and the direction of capital flows. Through the
transmission mechanisms of financial markets, they also impact key economic indicators such as
global economic growth, employment levels, and price stability. Thus, a systematic analysis of the
complex interactions between exchange rate changes and the global economy is essential to
address global economic challenges and promote the coordinated development of national
economies.
KEYWORDS
Macroeconomic model; Exchange rate fluctuations; Global economy
1. INTRODUCTION
In today's interconnected global economy, fluctuations in exchange rates not only affect the stable
development of a country's economy but also have profound impacts on the global economic
landscape, making them a core variable in international economic interactions [1-3]. With the
accelerated pace of globalization, international trade, capital flows, and financial markets are
interdependent, and exchange rate fluctuations can easily trigger chain reactions that affect the global
economy. Therefore, in-depth analysis of the correlation between exchange rate fluctuations and the
global economy is of significant importance for understanding global economic dynamics and
formulating economic policies. This paper comprehensively analyzes the factors influencing
exchange rate fluctuations based on macroeconomic models and reveals the intrinsic connections
between exchange rates and key economic sectors such as economic growth, international trade,
capital flows, and financial markets, to address the challenges of global economic integration and
promote sustainable global economic development.
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2. INTRODUCTION TO MACROECONOMIC MODELS
2.1. Basic Framework of Macroeconomic Models
In the course of analyzing economic trends, macroeconomic models serve as an essential tool, based
on a deep understanding and integration of various key areas within economic systems [4-5]. As
shown in Figure 1, these models encompass the goods market, revealing the dynamics of price and
output under the law of supply and demand, and they conduct in-depth analysis of interest rate
changes in the money market, affecting capital flows and savings-investment behavior. Integrating
the foreign exchange market helps the model capture how international capital flows and exchange
rate fluctuations cross borders to impact the global economic landscape. The labor market is a crucial
foundation when conducting economic activities, and the model elaborates on employment conditions,
wage levels, and labor productivity. As these sub-markets interact, the model can accurately predict
economic trends, formulate scientific macro-control policies, and promote the development of
macroeconomic theories.
Figure 1. Multi-Dimensional Sub-Market Display
2.2. Key Variables of Macroeconomic Models
In the field of economics, macroeconomic models are a crucial analytical tool containing multiple
key variables, as shown in Figure 2. These variables are closely related and mutually influential. GDP
is a key indicator measuring the total economic activity of a country; its growth directly reflects the
level of economic prosperity. The inflation rate reveals trends in price levels, affecting consumers'
purchasing power and businesses' production costs. As the price of capital, interest rate fluctuations
influence the pulse of capital markets, significantly impacting investment, savings, and consumption
behavior. Exchange rates, as a bridge in international economic interactions, affect the
competitiveness of international trade and the direction of international capital flows. The
unemployment rate directly reflects the supply and demand in the labor market and is an important
indicator of economic health. The trade balance reflects a country's status and competitiveness in the
international economic system. These variables interact and constrain each other, collectively shaping
the economic operating state and development trends [6-8].
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Figure 2. Key Variables Involved in Macroeconomic Models
3. ANALYSIS OF FACTORS INFLUENCING EXCHANGE RATE
FLUCTUATIONS
3.1. Economic Fundamentals
When international markets assess the value of a currency, key factors such as the growth potential
of the economy, the stability of price levels, and the balance of international economic transactions
are measured. When a country maintains a robust economic growth rate, it signifies high production
efficiency and strong innovation capability, attracting more foreign capital inflow, creating upward
pressure on currency value. Controlling inflation is a crucial factor in exchange rate stability; if a
country can effectively manage price levels and maintain a low inflation rate, it builds confidence
among domestic and foreign investors. A low inflation environment helps maintain the purchasing
power of the currency. When a country achieves an international balance of payments surplus, where
export income exceeds import expenditure and foreign payments, it indicates that the country has
strong competitiveness in the international market, enhancing the international status and credibility
of its currency, leading to an appreciation expectation in the market.
3.2. Market Supply and Demand Factors
The dynamic changes in market supply and demand directly affect the valuation of global currencies.
In the volatile foreign exchange market, when the demand for a currency surges beyond current
market supply, the currency becomes scarcer, pushing up its exchange rate. This demand might stem
from the prosperity of international trade, such as increased exports driving higher foreign exchange
income and subsequently increasing demand for that currency. With the deepening of globalization,
international capital seeks optimal allocation globally, and the inflow or outflow of capital directly
affects a country's foreign exchange reserves and money supply, thereby changing market supply and
demand for that country's currency. When market participants forecast economic trends, they make
adequate preparations, increasing demand for that currency and driving up exchange rates. Therefore,
supply and demand relationships and the multitude of influencing factors constitute a complex picture
of exchange rate fluctuations [9-11].
3.3. Policy and Institutional Factors
Policy and institutional factors profoundly impact market supply and demand relationships in
exchange rate fluctuations, even reshaping exchange rate trends. In terms of monetary policy, central
banks influence domestic economic and financial market environments by adjusting interest rates and
money supply, guiding changes in foreign exchange market supply and demand. For instance, a tight
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monetary policy might raise domestic interest rates, attracting foreign capital inflow and increasing
demand for the domestic currency, thereby pushing up exchange rates. Regarding fiscal policy, the
government influences economic growth, inflation levels, and international balances through
adjustments in spending and tax policies, and these changes eventually reflect in exchange rates. For
example, expansionary fiscal policy might stimulate economic growth and enhance international
competitiveness, favoring currency appreciation. The main factor determining exchange rate
fluctuations is the exchange rate system itself. Fixed and floating exchange rate systems each have
their advantages and disadvantages, imposing varying constraints and influences on exchange rates
in different economic environments. Policy-makers must carefully choose exchange rate systems to
balance internal and external economic objectives.
4. ANALYSIS OF THE CORRELATION BETWEEN EXCHANGE RATE
FLUCTUATIONS AND THE GLOBAL ECONOMY
4.1. Analysis of International Trade Correlations
Exchange rate fluctuations directly impact trade patterns among countries, serving as a barometer for
international trade. When a country's currency appreciates, the prices of export goods increase in
international markets, weakening their price competitiveness, reducing international demand, and
decreasing export volume, posing challenges for export-dependent economies. Conversely, if a
currency depreciates, export goods become more attractive, highlighting price advantages and
expanding international market share, promoting export prosperity. Additionally, exchange rate
fluctuations indirectly affect domestic economies by influencing the prices and quantities of imported
goods. Currency appreciation implies cheaper imported goods, stimulating domestic consumption
and increasing import volumes but also impacting domestic industries of similar types. Currency
depreciation raises import costs, affects domestic price stability, and encourages local industry
protectionism.
4.2. Analysis of Capital Flow Correlations
In international financial markets, exchange rates act as a crucial regulator, and cross-border capital
flow patterns change accordingly. When a country's currency appreciates, foreign investors' actual
purchasing power increases after converting to that currency, enhancing expectations of investment
returns. As the value of capital-priced assets rises, it attracts substantial foreign capital, injecting
vitality into the domestic market and promoting economic growth. However, with currency
depreciation, investors worry about capital depreciation and may choose to withdraw funds to
mitigate risks, leading to capital outflow, reduced market liquidity, and even financial market
volatility, challenging macroeconomic stability [12]. Thus, policy-makers should constantly monitor
exchange rate dynamics and take appropriate measures to balance capital flows, maintain domestic
financial market health, and ensure stable macroeconomic operations.
4.3. Analysis of Financial Market Correlations
Exchange rate fluctuations and the financial market are closely linked, with their interactions forming
a complex network of global economic interactions. The profitability and international
competitiveness of multinational corporations are influenced by exchange rate fluctuations, affecting
stock valuations and leading to stock market volatility. Meanwhile, bond market yields adjust
according to changes in exchange rate expectations. Investors consider exchange rate risks when
evaluating bond investment returns, leading to adjustments in risk preferences and asset allocation
strategies due to uncertainties, affecting financial market trends on a broader level. Conversely, if
financial markets experience severe fluctuations, such as a stock market crash or bond market turmoil,
it may trigger investor concerns about macroeconomic and monetary policies, leading to a flow of
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safe-haven funds. The supply and demand relationship in exchange rates will also be affected,
ultimately influencing exchange rate trends.
5. MANAGEMENT AND REGULATION STRATEGIES FOR EXCHANGE
RATE FLUCTUATIONS
5.1. Monetary Policy Adjustments
Monetary policy is one of the essential tools for regulating the macroeconomy. Typically, central
banks make precise adjustments to respond to fluctuations in the foreign exchange market. However,
with the deepening of global economic integration, exchange rate fluctuations not only affect
international trade and capital flows but also impact a country's economic security and stability, as
shown in Table 1. Therefore, when facing upward pressure on the exchange rate, central banks should
consider lowering interest rates to attract foreign capital flows by reducing the cost of loans, thereby
increasing the supply of domestic currency in the market to alleviate appreciation pressure [13].
Conversely, when facing depreciation pressure, central banks can raise interest rates to enhance the
attractiveness of the domestic currency, stabilize exchange rate expectations, and thus maintain stable
domestic economic operations and external stability. Such monetary adjustment policies can respond
promptly to market conditions and safeguard national economic interests.
Table 1. Impact of Monetary Policy Adjustments on Exchange Rates
Monetary policy
will adjust its
direction
Exchange rate impact
Change in interest
rate
Purpose
Lower interest
rates
Attract foreign capital
inflows and ease the
pressure on domestic
currency appreciation
Go down
Increase market liquidity,
promote economic growth
and balance the balance of
payments
Raise interest rates
Restrain the
depreciation of the
local currency and
stabilize the exchange
rate
Go up
Attract domestic and
foreign capital, enhance the
value of money, and
maintain the stability of the
financial market
Implementation of
quantitative easing
Increasing the money
supply may indirectly
affect the depreciation
of the exchange rate
There is no
immediate change,
but market interest
rates may fall
Stimulate economic
recovery, increase the
supply of credit, and fight
deflation
Balance sheet
reduction
Reducing the money
supply may indirectly
affect exchange rate
appreciation
There is no
immediate change,
but market interest
rates may rise
Control inflation, prevent
economic overheating, and
stabilize financial markets
5.2. Foreign Exchange Market Intervention
To maintain exchange rate stability and promote balanced economic development, foreign exchange
market intervention is a primary tool for central banks. When exchange rate fluctuations exceed
expected ranges, especially if the appreciation or depreciation rate is too rapid, central banks intervene
in the foreign exchange market by directly buying or selling foreign currency to influence market
supply and demand. In cases of rapid appreciation, central banks sell domestic currency and buy
foreign currency to increase the domestic currency supply in the market, thus reducing its value and
slowing the appreciation. Conversely, if the domestic currency depreciates too quickly, central banks
460
buy domestic currency and sell foreign currency to reduce its circulation, thereby increasing its value
to stabilize the exchange rate and prevent excessive depreciation from impacting the domestic
economy. A relatively flexible foreign exchange market intervention mechanism allows central banks
to efficiently manage exchange rate risks and maintain national financial security [14].
5.3. Choice of Exchange Rate Regime
The choice of exchange rate regime directly affects the stability of a country's economy. A fixed
exchange rate regime ensures exchange rate stability, reducing exchange rate risks in international
trade and investment and achieving external economic balance, but it may weaken the independence
of monetary policy, making it challenging to adjust to various external shocks flexibly. In contrast, a
floating exchange rate regime provides more independence for monetary policy, helping countries
respond flexibly to domestic economic changes, but it may also intensify exchange rate volatility and
increase economic uncertainty. Therefore, when choosing an exchange rate regime, countries must
comprehensively assess their economic conditions, industrial structure, financial market maturity,
and external environment to weigh the pros and cons and select the most suitable exchange rate
regime for their development, achieving the dual objectives of economic stability and sustainable
growth.
6. CONCLUSION
In conclusion, in the context of deep global economic integration, exchange rate fluctuations directly
impact global economic development, even shaping the pattern of international trade and the global
allocation of capital. Through the amplifying effect of financial markets, they profoundly influence
the economic growth, employment situation, and social stability of various countries. To address the
challenges posed by exchange rate fluctuations, governments and international organizations should
adhere to the principles of openness and cooperation, strengthen policy communication, and work
together to maintain global economic stability. Meanwhile, they should flexibly adjust exchange rate
policies according to the development conditions of different countries to adapt to the new trends of
global economic integration and achieve sustainable development of their economies.
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