In this video we will examine some of thefactors that underly changes in exchange rates.
These will mostly apply to floating and managedfloat exchange rates.
The fixed exchange rate can change when thegovernment seeks to devalue or revalue the currency in order to achieve a macroeconomicobjective such as moving towards a more favourable trade balance.
Some of these factors were discussed earlierin the floating exchange rate video.
I’ll take each of these one by one and clarifythem for you.
Let’s start with the demand for the goodsand services produced by a nation.
As the demand rises for the goods and servicesfor a nation the derived demand for the currency increases and thereby causes the currencyto appreciate.
I’ve included an image of India’s exportsin 2013-2014 as measured in dollars.
As India’s reputation for the productionof some of these goods improves, their likelihood of exporting these goods may rise.
Additionally, a rise in incomes of a majortrading partner may also cause them to export more to those markets.
These changes in demand can work in the oppositedirection also, with decreases in demand causing the currency to depreciate.
If you look at the US inflation rate fromthe years 1910 – 2010 you’ll notice some peaks and dips.
Consider the impact rising inflation rateswould have on countries that import a lot of American goods.
Depending on demand elasticity, rising pricescould discourage them from buying American products and lead them to switch to the exportsof a lower cost producer.
If this happens, demand for the dollar alsofalls and it should depreciate.
Remember, whatever causes the dollar to depreciatecan work in the other direction as well, causing it to appreciate.
Higher interest rates attract foreign investorswho would like to deposit their money in more rewarding accounts.
The higher interest rate should attract moneyinto the country and increase the demand for the currency as deposits are mostly held inthe local currency.
Higher interest rates would cause the currencyto appreciate.
Lower interest rates would have the oppositeeffect.
I’ve included a graph of the net inflowsof Jordan’s foreign direct investment to illustrate this point.
As more money flows into Jordan as FDI itwill increase the amount of the currency demanded and cause the currency to appreciate.
The extent of that appreciation due to FDIwill be larger if the flows are more significant.
I’ve also included asset purchases herewhich could include property and bonds.
In order to purchase Jordanian property andbonds it would require use of the Jordanian dinar.
If foreign buyers are interested in purchasingJordanian assets or investing in the country, they must exchange their currency and purchasethe dinar, causing it to appreciate.
This could also work in the other directionas well.
Currency speculators purchase currency fora variety of reasons.
Mostly, they are trying to gain from fluctuationsthey anticipate in the future.
If this is the case and demand for the currencyrises, then the value of the currency will rise as well.
This also works in the opposite direction.
That wraps up this video on the factors underlyingchanges in exchange rates.
Once again, if you have any questions or commentsplease leave them below, email me at enhancetuition@gmail.
Com or tweet me @enhancetuition.
We’re almost through Unit 4 and you’vemade excellent progress if you’re understanding all the material thus far.
That’s us done for now and I will see youin the next one!.