Floating Exchange Rate Changes

• Exchange rate


  The price of one currency in terms of another currency
• How an exchange rate can appreciate

  1. Demand for the currency increases

  2. Supply of the currency remains the same

  3. Exchange rate appreciates
• How an exchange rate can depreciate

  1. Supply of the currency increases

  2. Demand for the currency remains the same

  3. Exchange rate depreciates
• Equilibrium exchange rate

  The initial price of 1 pound = 1.60 dollars
• Demand for the pound increases


  Exchange rate appreciates
• Supply of the pound increases

  Exchange rate depreciates
• Reasons for increased demand for the pound

  • Increase in relative interest rates
  • Speculation of pound appreciation
  • Increase in foreign direct investment
  • Increase in foreign incomes
  • Increase in UK export competitiveness
• Reasons for increased supply of the pound

  • Decrease in relative interest rates
  • Firms leaving the UK
  • Increase in domestic incomes leading to more imports
• When the exchange rate appreciates, the pound can buy more of another currency
• When the exchange rate depreciates, the pound can buy less of another currency