What is the connection between interest rates and currencies?

Why interest rates change the value of currencies?

By | 2013-08-25T19:18:59+00:00 August 25th, 2013|Mortgages Home Loans Interest Rate|2 Comments

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  1. simplicitus August 25, 2013 at 7:40 PM - Reply

    1. In the days before the Catholic Church reinterpreted the word “usury” to mean unreasonable interest and forbade any lending with interest between Christians, the Italian banks used to get around the prohibition by lending in one currency, writing the contract so that loan repayment was in a different currency, and adjusting the exchange rate specified by the contract
    http://en.wikipedia.org/wiki/Medici_Bank#Bills_of_exchange

    2. More recently, when capital could flow freely from country to country, given two countries offering bonds or bank deposits, assuming equal risk, investors would put their money in the one with higher returns – higher interest rates. Since that currency would become more desirable, it would become more valuable.

    At the same time, low interests encourage people to borrow. Borrowing creates money and so increases the money supply.
    http://en.wikipedia.org/wiki/Fractional-reserve_banking
    A larger money supply for the same volume of goods and services results in inflation.
    http://en.wikipedia.org/wiki/Inflation
    Inflation causes the value of a currency to decrease.

    So low interest rates can (but don’t always) cause the value of a currency to decrease, while high interest rates can (but don’t always) cause the value of a currency to increase.

  2. SDD August 25, 2013 at 7:29 PM - Reply

    Interest rates are the price of owning a currency.

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