Assessing the health of an economy is always a complicated task, as there are many indicators to observe and their interpretation requires various theories and economic models. Faced with so much complexity, people tend to choose a variable that serves as a thermometer, with the exchange rate being one of the most popular.
In our country, the economic crisis of 2003 was accompanied by a strong devaluation that generated a significant increase in the cost of the family basket, while during the recovery in 2004-2005 the Dominican peso recovered once morest the dollar and prices stabilized. . From then on, it is interpreted that an economy is strong if it remains stable or if the exchange rate appreciates, and in the face of any sign of devaluation, old fears from the past are revived.
However, judging the state of the economy from the exchange rate can be misleading. In the 1980s and 1990s, the Chinese yuan was constantly depreciating, while the Chinese economy experienced years of unprecedented dynamism. Just the opposite occurred in Japan, where the Japanese yen gradually gained value once morest the dollar, but the Japanese economy entered the nineties in a painful stagnation.
In the North American case, both in the economic crisis of the early eighties and in the Great Recession of 2008-2009, the dollar appreciated strongly once morest most world currencies. So, it is normal to ask, what determines the depreciation or appreciation of a currency? To better understand the answer, it is important to remember that the exchange rate is the price of one currency once morest another, and all prices are the result of the interaction between supply and demand.
Various factors can alter the supply and demand for foreign exchange, with the interest rate almost always being the most important. And it is that when a country increases the interest rate more than the rest of the world, it makes it more profitable to invest in its currency, so many national and international investors go on to buy the currency of the country that recently increased its rate, they invest their funds in financial instruments in that currency and enjoy a higher yield.
An example of this is the US dollar, which in recent days has appreciated so significantly that it reached parity with the euro. Since the birth of the euro at the beginning of the 21st century, almost all the time it took between 1.1 and 1.6 dollars to buy a euro, but in recent days the dollar and the euro are worth the same.
This is explained by the successive increases in the interest rate made by the United States Federal Reserve during the first six months of the year, but also because it has announced that it will continue to raise the interest rate during 2022 and 2023. On the contrary, the European Central Bank has not made any rate hikes, and has been very unwilling to make significant increases in the near future.
Given this situation, it is not only normal that the dollar has reached parity with the euro, but it can be expected that the US currency will continue to appreciate in the coming months. Something similar has happened in our country, since the Dominican Central Bank has been in a race to raise interest rates since November of last year, so much so that the 3-year investment instruments issued by the Central Bank in November 2021 had a yield of 4.8%, and those issued in February 2022 had a yield of 8.5%. In other words, in just 4 months the interest rate on these instruments almost doubled. As a result, the peso appreciated 5% at the beginning of the year, something unusual in the dynamics of the Dominican exchange. Regarding the future perspective, it is expected that the Dominican Central Bank will continue with important adjustments in the interest rate, thus generating greater profitability in investments in pesos compared to investments in dollars, for which it is expected that the Dominican peso will remain stable, or even continue to appreciate.
This appreciation is not a reflection of the strength or weakness of the Dominican economy, it is simply the natural result of the increase in interest rates. Looking to the future, we must get used to the fact that sometimes the dollar goes up and sometimes it goes down, and that exchange rate movements should not be seen as a sign of concern or confidence in the future.
