Global Financial Crisis and Hong Kong

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1.Introduction

The fixed-linkage system was implemented in Hong Kong since 1983. The interest rates and exchange rates of Hong Kong therefore are closely related to U.S. This report is conducted to examine the influence of U.S. and Hong Kong interest rates and exchange rates movements on Hong Kong economy, the stock markets and the property markets.

1.1Hong Kong exchange rates
Before the implementation of linked exchange rate system, the Hong Kong exchange rates were volatile. During the period 1981-1984, the rates were fluctuated from HKD$5.13 to HKD$8.3 in exchange of USD. Hong Kong was full of speculative behaviors and fear of depreciation of HKD. Dueling with the monetary crisis, in October 1983, the Government announced the policy fixed-linkage system to stabilize the fluctuation of Hong Kong currency. The influence of the linkage system was very noticeable. After the enforcement of this system, Hong Kong exchange rate maintained very steady even experienced the stock disaster (1987), the Gulf War (1990), the exchange rate mechanism in Europe (1992), the monetary crisis in Mexico (1994-1995), the financial crisis in Asia (1997-1998) and the “911 incident” (2001). Exchange Rate of Hong Kong dollars/ U.S.Dollars, 1981-2010

The Link also suggests that the movements of interest rates and exchange rates between Hong Kong and the US are strongly related. Currently, due to the depreciation of US dollar, the value of Hong Kong dollar also lowered. Some people would then question the effectiveness of the linked exchange rate system. This report is going to deeply examine how Hong Kong economy, the stock markets and the property markets be affected by the movements of the interest rates and exchange rates.

1.2Hong Kong interest rates
The interest rates play a vitally important role in the fixed-linkage system. The automatic interest rate adjustment mechanism contributes to sustain the stability of Hong Kong exchange rate. The graph below shows how the linkage system works and how exchange rates and interest rates of U.S. and Hong Kong are related.

In an open economy, the difference in interest rates in different regions will cause changes in their exchange rate. Investing in a region with high interest rate is more attractive than in a region with low interest. As graph below, when U.S. decreases interest rate, the capital market of Hong Kong will become more attractive than U.S. as it provides higher rate of return. More capital will flow into Hong Kong in exchange for Hong Kong dollar. The demand of Hong Kong dollar will thus be increased. That produces the upward pressure on the Hong Kong dollar exchange rate. At that time, Hong Kong Monetary Authority will sell Hong Kong dollars to the market which will increase the supply of Hong Kong dollars. The main purpose of this action is to drive down the interest rate. It eliminates the difference of interest rate between U.S. and Hong Kong, and thus the appreciation pressure of Hong Kong dollar. HKMA works on stabilizing the exchange rate between Hong Kong and U.S. by amending the tool of interest rates.

2.The Hong Kong Economy

On the October 17, 1983, the Linked Exchange Rate System was adopted in Hong Kong as a response to the Black Saturday crisis. Since then, the Hong Kong exchange rate and interest rate tightly followed the movement of that of U.S. economy. This situation implies that an increase in interest rate in U.S. will lead to an increase of interest rate in Hong Kong, vice versa. In order to examine the influence of changes in exchange rate and interest rate to the Hong Kong economy, we will discuss the Gross Domestic Product, unemployment rate and Consumer Price Index in Hong Kong in the following parts.

2.1Gross Domestic Product
Gross domestic product (GDP) calculates the value of all final goods and services produced within a nation in a given year. It shows the performance of economy and...
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