How Exchange Rate and Interest Rate Affect Hong Kong Market

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In 1983, Hong Kong implemented Fixed-linkage System to US currency because of the reason that Hong Kong currency was very unstable. This Fixed-linkage System is a fixed exchange rate system that fixes the exchange rate of Hong Kong Dollar and United State Dollar to a ratio of 7.8: 1 Hong Kong Monetary Authority does not need to stable exchange market by controlling the supply and demand of HKD. It can be stabilized by Fixed-linkage System. In the past 15 years, Hong Kong interest rates and exchange rates fluctuated in the same trend of the US interest rate and exchange rate. The graphs below show an example of interest rate and exchange rate respectively: [pic]

We can see that their trends and fluctuations are normally the same. In this report, we describe how this Fixed-linkage System affects the Hong Kong economy, the stock markets and the property markets.

Hong Kong Economy


i) GDP:

To measure the economic condition of Hong Kong throughout the 15 years, Gross Domestic Product (GDP) is the indicator we used.

GDP is defined as ‘the market value of all final goods and services produced within a country in a given period of time.’ (#1) It measures the total spending on goods and services in all markets in the economy.

GDP (Y) is constituted by four elements, namely Consumption ( C ), Investment (I), Government Purchases(G), and the Net Exports(NX); Their relationships are denoted by the following equation:

Y = C + I + G + NX

Consumption is the households’ spending on goods and services except housing;

Investment is the spending on goods which will be used to produce more goods and services; Government Purchase is the expenditure on goods and services by the local government;

Net Exports is the difference between the exports and the imports.

Graph 1

Chain Volume Measures of GDP is a more accurate measure of GDP using effective average volume for the goods and services produced by a region in a given period of time.

ii) Unemployment:

Unemployment rate is another good indicator showing the economic condition of a region since a better economic environment requires a larger production and also the labor forces.

Effect of Federal Fund Interest rate of U.S. to Hong Kong economy

|[pic] |The investment is deduced by the sum of the Gross | |Graph 2 |domestic fixed capital formation and the Changes in | | |inventories. | | |Lowering the interest rate increases the incentive to | | |borrow and invest. This improves the Investment (I) and | | |thus GDP. Lowering the interest rate helps the Hong Kong | | |economy. | | |In reality, the relation between investment and interest | | |rate is fairly an inversely proportion, i.e. similar to | | |what theory predicted, especially when we look at year | | |94-95, 99-01. | |[pic] |The change of net exports of Hong Kong is directly | |Graph 3 |proportional to that of interest rate. Lower interest | |...
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