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I came across the following idea from George Soros' book The Alchemy of Finance which is also discussed in the book The New Market Wizards (by Jack D. Schwager) during the latter's interview of S. Druckenmiller (student of G. Soros):

For a country, if a huge budget deficit is accompanied by an expansionary fiscal policy and tight monetary policy, the country’s currency would rise

What I do not completely understand is the meaning of the italicized terms "expansionary fiscal policy" and "tight monetary policy".

Please help me understand how is this actually possible that the two when applied to a huge deficit would lead to rise in the country's currency value.

Incidentally, while S. Druckenmiller gives an example (in the said interview) where he used Soros' idea to bet on German Deutschmark after the fall of the Berlin Wall and made huge profits out of it, I have also found evidence(?) for the opposite to be true as well. Take for instance the current scenario of Euro's drop in value (see picture below) where the nominal effective exchange rate of Euro is plotted over time between 2019 and present.

nominal effective exchange rate for the Euro between 2019 and present

Clearly, Euro became strong post pandemic as a result of expansionary fiscal AND expansionary (not hawkish/tightened) monetary policies –– including tax cuts, rebates and increased lending to SMEs while at the same time lowering the interest rates to near zero –– of the leading Member States of the EU like Germany; and now, when most EU govts are tightening their monetary policies –– with raising rates and lowering Quantitative Easing (following the US Fed) –– the Euro is depreciating!

This makes no sense to me and I think there are holes in my understanding of Soros' statement. So please help me clarifying my doubt. Thanks a lot in advance!

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  • $\begingroup$ Hi! Your question is incomplete: [the] "Euro became strong post pandemic" relative to what currency? $\endgroup$
    – Giskard
    Jul 13, 2022 at 20:45
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    $\begingroup$ You also claim that this is "Clearly [...] a result of expansionary fiscal AND expansionary (not hawkish/tightened) monetary policies". Can you please support this statement with a reference? It is not clear to me - perhaps because the competing currency and the fiscal and monetary policy of its administering country is unspecified. $\endgroup$
    – Giskard
    Jul 13, 2022 at 20:46
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    $\begingroup$ What exactly is the question though? It seems to me you do not ask about (expansionary) fiscal policy and (tight) monetary policy but rather want an explanation of what is happening to the EUR (the effective exchange rate in your case). Your claim that most EU govts are tightening their monetary policies is simply wrong. The EUR is a single currency and all members follow a unified monetary policy. Pretty much nothing happened in the Eurozone (monetary policy-wise) compared to trading partners like the US or the UK where interest rates rose substantially. $\endgroup$
    – Alex
    Jul 13, 2022 at 22:00

2 Answers 2

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expansionary fiscal policy: Fiscal policy is policy related to government spending, expansionary fiscal policy means government is going tp implement fiscal policies that spend more than previously.

tight monetary policy: Monetary policy is policy related to money supply in the economy. Tight monetary policy means that central bank will try to keep money supply from expanding or contract it.

Please help me understand how is this actually possible that the two when applied to a huge deficit would lead to rise in the country's currency value.

That quote does not offer any context. In simple monetary model of exchange rates tight monetary policy would lead to appreciation of exchange rate ceteris paribus (see Copeland Exchange Rates and International Finance). I do not know what is his reasoning for the high debt accompanied by fiscal expansion, perhaps he assumes that will boost real output which would also lead to an appreciation, ceteris paribus.

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  • $\begingroup$ Thank you @1muflon1 for your response. However, I don't think it completely answers my question. Since you asked for a bit of a context, here's some: worldoutofwhack.com/2021/12/16/…. Please let me know if this is sufficient. :) $\endgroup$
    – TAH
    Jul 13, 2022 at 19:40
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Part 1:

For a country, if a huge budget deficit is accompanied by an expansionary fiscal policy and tight monetary policy, the country’s currency would rise

Indeed, if the MP is tight, interest rates are high, money is scarce, this helps national currency appreciate. If FP is expansionary, it further increases scarcity of liquidity, and currency appreciates more.

Part 2:

Euro became strong post pandemic as a result of expansionary fiscal AND expansionary (not hawkish/tightened) monetary policies The relative magnitude matters! It is true that ECB's MP was expansionary, but you need to check if was more expansionary than the Fed's MP at the time. Also, the FP was not as expansionary (in relative terms) as the US' FP.

Part 3:

and now, when most EU govts are tightening their monetary policies –– with raising rates and lowering Quantitative Easing (following the US Fed) –– the Euro is depreciating! This is mirroring Part 2. The degree of the ECB's tightening is behind that of the Fed's etc. So in relative terms, ECB is not tightening (enough). Also, exchange rates reflect [relative] desirability/riskiness of currencies, etc. As long as economists/analysts believe that US economy would handle the current econ slowdown better than the EU economy, ceteris paribus, euro should should be weakening.

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