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Currency Flow And Exchange Rate Determination
The document discusses currency flow, detailing its inflow and outflow between countries driven by international trade and transactions, and the role of balance of payments in recording these transactions. It also explains exchange rate determination, covering fixed versus floating exchange rate systems, currency depreciation and appreciation, and factors influencing exchange rates such as inflation and interest rates. Finally, the relationship between balance of payments and exchange rate systems is analyzed, highlighting how flexible and fixed systems address deficits differently.
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Currency Flow And Exchange Rate Determination
- 1. Currency FlowCurrency Flow &Exchange& Exchange RateRate DeterminationDetermination By :- Shubham Mittal 2018-20 Kurukshetra university-usm
- 2. Currency Flow Currency flowis the inflow and outflow of currency from one country to another country. Currency flow between countries is generated from international trade and other major international transactions. Each of the above transactions is recorded in the balance of payments and balance of trade record of each country. Trading balance may include the flow of currency, goods & services, economic claims gifts and claims traded by government.
- 3. Balance of Payments Accordingto the RBI, balance of payment is a statistical statement that shows 1. The transaction in goods, services and income between an economy and the rest of the world, 2. Changes of ownership and other changes in that economy’s , special drawing rights (SDRs), and financial claims on and liabilities to the rest of the world, and 3. Unrequited transfers or gifts. By RBI...
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- 7. Exchange Rate? Foreign ExchangeRate is the amount of domestic currency that must be paid in order to get a unit of foreign currency. According to Purchasing Power Parity theory, the foreign exchange rate is determined by the relative purchasing powers of the two currencies. Example: If a Mac Donald Burger costs $20 in the USA and Rs. 100 in India, then the exchange rate between India and the USA will be (100/20=5), 1 $ = 5 Rs. civilsdaily.com...
- 8. System of ExchangeRate 1. Fixed Exchange Rate System • Under this system, there is complete government intervention in the foreign exchange markets. • The government or central bank determines the official exchange rate by linking exchange rate to the price of gold or major currencies like US dollar. • If due to any reason, the exchange rate fluctuates, government intervenes and make sure that equilibrium pre- determined level is maintained.
- 9. 2. Floating ExchangeRate System •Under this system, the market is allowed to determine the value of exchange rate freely. •The exchange rate is determined by the forces of demand and supply. •If due to any reason exchange rate fluctuates, the government never intervenes and allows the market to function and determine the true value of exchange rate.
- 10. Currency Depreciation vs. CurrencyAppreciation Currency Depreciation •It refers to decrease in the value of domestic currency in terms of foreign currency. •A change $1=Rs62 to $1=Rs70. Currency Appreciation •It refers to increase in the value of domestic currency in terms of foreign currency. •A change $1=Rs70 to $1=Rs62.
- 11. Exchange rates ofUSD to INR for one month august- 2018
- 12. Exchange Rate Determination? Therate of exchange being a price of a national currency in terms of another, is determined in the foreign exchange market in accordance with the general principle of the “theory of value” , i.e. by the interaction of the forces of demand and supply. Thus the rate of exchange in the foreign exchange market will be determined by the interaction between the demand for foreign exchange and the supply of foreign exchange.
- 13. Exchange Rate Equilibrium Theequilibrium rate of exchange is the rate of exchange at which the par value of home currency with foreign currency is maintained at a stable level over a long period of time, which means it is neither undervalued nor overvalued.
- 14. Q N Q N FOREIGN CURRENCYSUPPLY & DEMAND X Y In this Fig, supply and demand are measured on the OX axis, and exchange rate on the OY axis. DD1 is the demand curve and SS1 is the supply curve of foreign exchange. Both these curves intersect at point E. It is an equilibrium point and OP is the equilibrium Rate of exchange. If the ROE rises to OP1 then supply of currency ON will exceeds in comparison of demand OQ by QN. Here, supply being more than the demand , ROE will come down to OP. On contrary, if the ROE falls to OP2 then demand for foreign currency ON will be more than the supply OQ by QN . Here, demand of foreign currency is more than the supply therefore ROE will again rise to OP. So Rate of exchange will be determined at a point where demand for and supply of foreign currency are equal.
- 15. How Factors CanAffect Exchange Rates
- 16. Factors that Influence ExchangeRates • Relative Inflation Rates India inflation ↑ Rs ⇒ ↑ India demand for USA goods, and hence demand of $ .↑ ⇒ ↓ USA desire for India goods, and hence the supply of $ .↓
- 17. Factors that Influence ExchangeRates • Relative Interest Rates India interest rates ↑ Rs ⇒ ↓ India demand for USA bank deposits, and hence demand of $ decreases. ⇒ ↑ USA desire for Indian bank deposits, and hence the supply of $ increases.
- 18. Factors that Influence ExchangeRates • Relative Income Level India income level ↑ Rs ↑ India demand for USA goods, and hence demand of $ increases. ⇒ No expected change for the supply of $.
- 19. Factors that Influence ExchangeRates • Relative Income Level USA income level ↑ Rs ↑ USA demand for Indian goods, and hence supply of $ increases. ⇒ No expected change for the demand of $.
- 20. Last Five yearExchange Rate for USD to INR (2013-18) By, poundsterlinglive.com…
- 21. Currency Flow andExchange Rate System Relation 1) Balance of Payments Equilibrium under the Flexible Exchange Rate System: Under the Flexible Exchange Rate System, the BOP is in equilibrium(i.e. the total currency flow is equal to zero) because any BOP disequilibrium will be automatically corrected through an adjustment of the exchange rate. A BOP deficit occurs when domestic money outflows exceeds money inflows which will lead to a downward pressure on the exchange rate. Under the Flexible Exchange Rate System, the resultant depreciation of domestic currency will lead to an increase in net exports which will correct the BOP deficit.
- 22. 2) Balance ofPayments Disequilibrium under the Fixed Exchange Rate System :- Under the Fixed Exchange Rate System, the BOP is in disequilibrium(i.e. the total currency flow is not equal to zero) because any BOP disequilibrium will not be automatically corrected through an adjustment of the exchange rate. A BOP deficit occurs when domestic money outflows exceeds money inflows which will lead to a downward pressure on the exchange rate. Under the Fixed Exchange Rate System, the central bank will intervene in the foreign exchange rate by buying domestic currency and selling foreign currency to prevent domestic currency from depreciating. Therefore net exports will not rise and the BOP will remain in deficit.
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