Factors That Impact The Exchange Rate Economics Essay

The exchange rate is the pace of which one currency deals against another on the foreign exchange market. The exchange rate reflects the position of the national economy in the backdrop of the world overall economy. The level of exchange rate represents an component of trustworthiness of the national monetary system. It really is considered as an important macroeconomic factor as part of the monetary insurance plan. Additionally, the recent Asian money crisis symbolizes how critically exchange rates impacts economic developments. The main element factor resulting in the turmoil was the maintenance of pegged exchange rate regimes which prompted exterior borrowing and led to excessive foreign exchange risk coverage.

This report can look into the different factors that influence the exchange rate and its impact on economy by making a relative contrast between US and UK and also highlighted some benefits of having weak currency.

Factors that influence exchange rate


Changes in comparative inflation rates make a difference international trade activity, which impacts the demand and supply of currencies and so affects exchange rates. For example, if US inflation rate raises and UK inflation rate continue to be the same, the United kingdom exports then tend to be more competitive which resulted in increased demand for United kingdom goods and hence US demand for UK currency increases.

In addition, the jump in america inflation should reduce the British demand for US goods and for that reason reduce the way to obtain pounds for sale. The US demand for pounds and reduced way to obtain pounds on the market will put an upwards strain on the value of pounds.

Interest rates

Changes in comparative interest rates affects the investment in foreign securities, which affects the demand for and supply of currencies and for that reason affects exchange rates. For instance if US interest rate rises and British interest rate remained same. In this case, demands for Uk pounds will probably to be reduced, since US rates are more attractive to the shareholders and there will be less desire for British bank deposits. Supply of pounds for sale by the English traders should increase as they build more banks deposits in america. This can be viewed as an inward shift in the demand for pounds and an outward switch in the supply of pounds for sale and hence the exchange rate should decrease. Sometimes, change in the interest to the third country can also influence the exchange rate between the two countries. Imagine if Canadian rates of interest increases, it becomes more appealing to the United kingdom investors than the US rate. The supply of pounds to be exchanged for dollars will be smaller which places an upward strain on the value of pounds against the united states dollar.

However, it is very important to consider the true interest as relative high interest may reflect objectives of relatively high inflation which can place downward pressure on the local money. So, real interest rate adjusts the nominal interest for inflation.

Real interest rate = nominal interest rate-inflation rate

Income levels

Another factor impacting exchange rate is the relative income level. Income level of the country can determine the imports demanded which affects the exchange rate.

If the US income level rises while the British degree of income remains the same. The scenario will symbolizes three situations: a) the demand schedule for pounds will alter outward reflecting the upsurge in US income and for that reason increased demand for United kingdom goods, b) the resource schedule of pounds on the market is not expected to change, c) exchange rate of pounds will climb.

Balance of payments

The balance of payments, the monetary variable that influence the exchange rate; a rise in the level of deficits decides the depreciation of the neighborhood currency while cut down will lead to an appreciation. For example, current consideration deficit in US of 7% of GDP was one reason for depreciation of buck in 2006-2007. Due to an undeniable fact that balance of repayment includes current account and capital profile, its impact on exchange rate is sophisticated sometimes reversed, so if a trade deficit which generally led to the depreciation of currency can be covered by the capital inputs so that it creates an appreciation on local money.

Some other factors are

Speculators make revenue through the margin they seek in investing of currencies. If speculators think that pound will go up in forseeable future, they will demand more now to be able to make more income. This increase in demand may cause the value to go up. Movement in the exchange rate is not always directed by the monetary fundamentals, but influenced by sentiments of financial markets.

Change in competitiveness

To boost the long run value of the currency, it is necessary to increase the competitiveness in the global marketplaces. For instance, if British goods become more attractive and competitive this will also cause the worthiness of exchange rate to rise.

Relative strength of other currencies is another factor that can determine the exchange rate and has a vice-versa result. For instance, between 1999 and 2001, the pound loved because the euro was regarded as a weak money.

Merits of vulnerable currency

Weak money also provides a great deal of opportunities

Increased exports

One of the largest reasons why weakened currency helps the overall economy is because it does increase the competitiveness of countrys goods. It improves the international demand while keeping the neighborhood consumers demand domestic. These great things about sale will result in more jobs and consumer spending and also reduce the trade deficit of the country.

Foreign investment

Foreign investment can support the countrys market and weak currency in various ways, if the money continues to fall season; foreign buyer may start to bunch on companies with sensible basics that are also less susceptible to financial slowdown. A weaker currency will also makes the businesses more appealing buyout targets. Sovereign wealth cash of several countries like china and Dubai are flush with cash and are searching for goods investment opportunities.

Increased travel and leisure

Tourism is recognized as major way to obtain revenue for most countries and also produces employment in the united states. Weak currency allures more travel and leisure as they offer more savings on the expenditure. For example, a USD $250 accommodation cost CAD $295, now it only cost CAD $250 which symbolizes 15% of savings.


This record has described the group of factors that affects the exchange rate you start with imports and export, interest, inflation rate and balance of repayment which are considered as the primary determinant of exchange rate. These key economic factors can effect exchange rate actions through their results on demand and supply conditions. These factors cause change in international trade or financial moves, they affect the demand for a money or way to obtain currency for sale and therefore have an impact on the equilibrium exchange rate. Then, the statement transferred towards merits of weak money which explored the opportunities like increased job, more consumer spending, overseas investment and tourism which immediately contributes towards countrys economy even during diminishing value of its local money.

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