Unit 6.4 - Exchange rates

• Exchange rate


  The price of one currency in terms of another currency
• A rise in country A's foreign exchange rate

  Would increase the cost of their exports
• Floating exchange rate


  • Determined by market forces
  • Currencies are bought and sold on the foreign exchange "market"
  • Buying and selling of large amounts of currency
  • Price is determined by the relative strength of the demand for and supply of the currency
• Why currency traders purchase the domestic currency

  • To purchase goods and services from the country (export)
  • To invest in the country
  • To speculate
• Depreciation


  A fall in the currency caused by market forces. Causes a reduction in export prices and an increase in import prices
• Appreciation


  A rise in the value of the currency, caused by an increase in demand and/or a decrease in supply. Will make exports more expensive and imports cheaper
• An increase in the supply of currency

  Causes depreciation of the currency
• Americans buying fewer UK products

  Causes appreciation of the dollar
• Causes of changes in exchange rates

  • Demand for the currency will rise if a higher value of exports is being sold, due to low inflation, high quality goods or higher consumer incomes
  • Foreigners purchasing currency to invest in foreign firms or open foreign bank accounts due to higher interest rates or speculations [Hot money flows]
  • Foreigners purchasing currency to open branches in that country
  • An increase in supply will cause a fall in the price: Selling currency to purchase other currencies, purchasing imports, speculating a fall in the currency
• Hot money flows


  Short-term flows of money moved around the world to take advantage of changes in interest rates and exchange rates
• Exchange rate depreciation


  Cheaper exports in foreign currency, imports more expensive in domestic currency. Increased domestic sales, cheaper domestic products, increased exports
• Exchange rate depreciation


  Higher AD because of a rise in net exports may result in inflationary pressure
• Exchange rate depreciation


  If there is higher AD, firms may have to take on more workers to expand output. May decrease cyclical unemployment
• Exchange rate appreciation


  Makes exports more expensive and imports cheaper. Causes a fall in demand for domestic products, declining economic growth and possibly a recession
• Exchange rate appreciation


  • May cause a reduction in inflationary pressure if close to or at maximum capacity (Yfe)
  • May also shift AS curve to the right because of lower costs of imported raw materials
• Exchange rate appreciation


  May increase unemployment if AD decreases
• The effect of a rise in net exports
• The effect of a rise in the exchange rate, reducing the growth of AD
• $100 over 2 weeks, % change