Exchange rate

Exchange rate is the price of one currency in terms of another currency.And most countries` exchange rate are determined by the market forces of demand and supply. Simply if demand for the currency rise, exchange rate rise whereas if the supply of the currency rise, the exchange rate fall.

When we talk about exchange rate, immediately we will link to interest rate and exports and imports.

• Interest rate.

When interest rate increases, exchange rate increases as well. It is because when interest rate increases, people tends to save more to benefit from the higher interest rates in the bank account, as same as foreigners,they want to buy pounds to open an UK bank account to gain from the high interest rate, therefore, the demand of one currency increases, thus exchange rage increases.(Diagram of increases in demand for pounds)

• Imports and exports

If exports are international competitive, the exchange rate of the country is likely to be high since the demand of pound is high and the supple of pound is low. In turn, when the exchange rate rise, SPICED, imports become cheaper and exports become more expensive. Or when the exchange rate fall, it make the exports more competitive, people tend to spend more on exports, thus is an injection to the circular flow, have a positive multiplier effect on the economy.( multiplier effect diagram).

Exchange rate are influenced by other factors as well,

• rise income at home country

Therefore, people are tend to spend more, the AD is tends to shift right wards. At the same time, people will spend more on imports, the demand for other currency in increased, it put an downward pressure on exchange rate.

• rise income at abroad.

It is just the opposite of rise income at home country.

Causes for rise in exchange rate.

• current account deficit
• trade deficit
• increases in production( imports are cheap)
• lower inflation(domestic market compete with imports)
• Slower econimic growth( AD shift inwards)