Economics Stack Exchange is a question and answer site for those who study, teach, research and apply economics and econometrics. It only takes a minute to sign up.
Sign up to join this community
What are the effects of quantitative easing on the foreign exchange rates?
If the central bank starts buying debt denominated in domestic currency, I would think that the market would be flooded with domestic currency, making it less valuable with respect to other currencies.
Are there any other effects which I'm not taking into account?
Any help would be appreciated
You've identified the first-order effect: the supply of local currency has increased, so its price (and from the perspective of other currencies, that's its exchange rate) decreases. That's assuming that the move wasn't already (fully) priced-in by the market.
There are lots of other effects.
There will be a change in domestic interest rates. The particular rates affected, depend on which debt has been bought. And there will be knock-on effects in those markets. This may affect inward investment in those markets.
QE in itself sends a couple of signals to the market. Firstly, that the Bank sees deflationary pressures a year or two ahead (assuming its mandate is an inflation-rate target); and secondly, that it intends to apply inflationary pressure to deal with it. The market will react to those signals, depending on how far they diverge from what the market had already anticipated. Those reactions might include increased optimism or pessimism about future domestic demand, and / or about the health of domestic industries, and that can have an affect on exchange rates.
In short, the central bank is pressing levers that touch on much of the macro-economic picture, so there are lots of second-order effects. The nature and direction of these effects will depend on expectations before and after the announcement, as well as what's actually going on in the economy.
