5) Causes of Exchange Rate Changes - MMT Flashcards
what is an x-rate?
price of one currency in the terms of another
if a country’s currency is allowed to float freely, what will happen to the exchange rate?
its exchange rate will be changing constantly due to variations in demand and supply of the currency on the FOREX
If the exchange rate is semi fixed, what will happen to the value of the currency?
only allowed within a narrow range (eg 2+ or - an agreed level), in this situation the country’s central bank will actively manage and influence the exchange rate
all x-rates, whether freely floating or managed will be determined by…
demand and supply of the currency (these are 2 sides of the same coin, the demand for one currency equates to the supply of another), eg if £ and $ were the only 2 currencies then to demand $ you would need to supply £s
what 6 factors affect exchange rates?
- inflation
- interest rate
- current account deficit
- terms of trade
- public debts
- political stability and economic performance
what happens when interest rates increase?
Exchange rates increase
what happens when interest rates fall?
exchange rates fall
why odes a higher interest rate mean a higher exchange rate?
hot money wants to get into, D for currency increases
what does a higher interest rate mean for inflation?
lower inflation, meaning a higher demand for exports, and a higher demand for currency
if the government is high in debt, what happens to the exchange rate?
fall in the x rate
why does high government debt mean a fall in the x rate? 3 things
- large scale deficit financing to pay for G
- less attractive to foreign investors, seek out stable countries with strong economic performance, in which to invest their capital
- large debt encourages inflation, if inflation is high, the real value of the currency falls, which means the currency is less attractive/less demand
why does political turmoil mean a fall in the x rate?
loss of confidence in a currency, a movement of capital to the currencies of more stable countries (capital flight)
what does a high trade surplus mean for the x rate?
- (X > M), high demand for currency so strong x rate
what does a high trade deficit mean for the x rate?
(M>X) associated with high supply of currency so weak x rate
what does a quicker increase export prices relative to import prices mean for the exchange rate?
if export prices rise more quickly than import prices, this may indicate stronger demand for currency, therefore high x-rate
