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Foreign exchange rate determination
The document discusses factors that determine foreign exchange rates, including: - Fundamental factors like the balance of payments, economic growth rates, fiscal and monetary policy, interest rates, and political stability. - Technical factors like government control of exchange rates and capital flows between countries. - Speculation, which can increase exchange rate volatility. It also examines how market fundamentals, expectations, and capital asset transfers impact exchange rates in the short-term, while economic activity, inflation, investment, trade policy influence long-term exchange rates. Purchasing power parity is discussed as a better way to compare GDP between countries than market exchange rates.
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Foreign exchange rate determination
- 1. Assignment on Unit –5 Macro Economics and policy FOREIGN EXCHANGE RATEDETERMINATION Submitted to : Dr. Y. C. Zala Principle & Dean college of IABM AAU Anand - 388110 1 Submitted by : Sondarva Yagnesh m Reg. no. 04-2664-2015 M.Sc. (Agri.) 1st Sem.
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- 3. Foreign Exchange Rate What is Exchange Rate ? Exchange Rate is a rate at which one currency can be exchanged into another currency. In other words it is value one currency in terms of other. say: US $ 1 = Rs.45.18 This rate is the conversion rate of every US $ 1 to Rs. 45.18
- 4. Factors Determining ExchangeRates (a). Fundamental Reasons: - Balance of Payment – surplus leads to stronger currency. - Economic Growth Rates –High/Low growth rate. - Fiscal / Monetary Policy- deficit financing leads to depreciation of currency. - Interest Rates –currency with higher interest will appreciate in the short term. - Political Issues –Political stability leads to stable rates (b). Technical Reasons - Government Control can lead to unrealistic value. - Free flow of Capital from lower interest rate to higher interest rates. (c). Speculation – higher the speculation higher the volatility in rates
- 5. What Determines ExchangeRates? Factors that cause the supply and demand schedules of currencies to change Market fundamentals (economic variables) Productivity, inflation rates, real interest rates, consumer preferences, and government trade policy Market expectations News about future market fundamentals Traders’ opinions about future exchange rates 5
- 6. What Determines ExchangeRates Factors affecting exchange rates Short term: transfers of assets Differences in real interest rates and to the shifting expectations of future exchange rates Interim: cyclical factors Fluctuations in economic activity Long term: flows of goods, services, and investment capital Inflation rates, investment profitability, consumer tastes, productivity, and government trade policy 6
- 7. Determining Long-Term Exchange Rates Exchange rate changes Reactions of traders in the foreign- exchange market to changes in Relative price levels Relative productivity levels Consumer preferences for domestic or foreign goods Trade barriers 7
- 8. Determining Long-Term Exchange Rates Increase in the U.S. price level relative to price levels in other countries Increase in the demand for foreign currency Decrease in the supply of foreign currency Depreciation of the dollar 8
- 9. Determining Long-Term Exchange Rates U.S. productivity growth is faster than that of other countries Increase in the supply of foreign currency Decrease in the demand for foreign currency Appreciation of the dollar 9
- 10. Determining Long-Term Exchange Rates An increased demand for U.S. exports Appreciation of the dollar An increased demand for U.S. imports Depreciation of the dollar U.S. imposes trade barriers Appreciation of the dollar 10
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- 16. International comparisons ofGDP: purchasing power parity Gross domestic product (GDP) Add up the market values of the goods and services its economy produces Use market exchange rate Misleading: not all goods and services are traded in a world market 16
- 17. International comparisons ofGDP: purchasing power parity Exchange rates Overstate the size of economies with relatively high price levels Understate the size of economies with relatively low price levels Subject to sizable fluctuations 17
- 18. 18 Comparing GDPs internationally,2008: top 8 countries (billions of dollars)