The following report appeared in the New York Times on August 7, 1989 ("Dollar's Strength a Surprise," p. D1):
But now the sentiment is that the economy is heading for a "soft landing," with the economy slowing signi?cantly and in?ation subsiding, but without a recession. This outlook is good for the dollar for two reasons. A soft landing is not as dis- ruptive as a recession, so the foreign investments that support the dollar are more likely to continue.
Also, a soft landing would not force the Federal Reserve to push interest rates sharply lower to stimulate growth. Falling interest rates can put downward pressure on the dollar because they make investments in dollar-denominated securities less attractive to foreigners, prompting the selling of dollars. In addition, the optimism sparked by the expectation of a soft landing can even offset some of the pressure on the dollar from lower interest rates.
a. Show how you would interpret the third paragraph of this report using this chapter's model of exchange rate determination.
b. What additional factors in exchange rate determination might help you explain the second paragraph?