What is the importance of exchange rates?
The exchange rate determines the price of imports and exports. Case in point, when the exchange rate of a currency appreciates the value of the currency increases and it becomes with more valuable in comparison to foreign currency (Adamson, 1941). Consequently, the exports become more expensive, making the country earn more from constant volumes of export sales. Nevertheless, the same factor has a negative effect as it reduces the number of goods that a country exports since the demand for its products falls. On the other hand, if currency depreciates it becomes less in comparison to other currencies. This makes the exports cheaper, increasing the number of exports made due to higher export demand. On the other hand, it reduces the amount of imports.
At the same time, the currency affects the level and prices of imports. The level of the foreign exchange in a country is a determinant of the import price variation on a daily basis. When a country’s foreign exchange increases, its imports become cheaper, making the consumers of the country purchase more imports since the demand for imports rises. Contrastingly, when the foreign exchange depreciates, the consumers purchase fewer imports.
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The foreign exchange also determines the aggregate demand (AD) in a nation. That consequently affects the gross domestic product of a nation (Baillie & McMahon, 2009). When a nation’s currency appreciates, the X-M becomes lower, as there is lower demand for exports and greater spending on imports (Yu, Wang, & Lai, 2007). As a result, the aggregate demand falls and so does the nation’s economic growth. A depreciation of a currency causes higher demand for exports and a lower spending on imports. It raises the AD and the economic growth of a nation.
At the same time, the exchange rate affects the inflation in a nation. Inflation refers to the increase in prices and fall in a currency’s purchasing power (Clark& Ghosh, 2004). An example is seen when a country’s currency appreciates since that causes the imports to be cheaper as earlier stated. At the same time, it causes slower AD, which causes a low demand-pull inflation. At the same time, the export prices become more expensive and manufacture is forced to cut costs to remain competitive. The opposite is true during currency depreciation.
Who benefits and who loses when a country’s currency appreciates?
During a currency appreciation, the trade balance of the country is improved since the prices of the traded goods incorporate appreciation in a faster manner while volumes take longer to adjust. The above has a divergent effect on the real and nominal trade balance. The result is that exporting activities become less profitable, as the goods from competitors are relatively cheaper in the foreign markets. Moreover, production in the home country is also more attractive. Volumes of exports fall since the customers prefer the competitor’s goods (Yu, Wang, & Lai, 2007). At the same time, the higher valued currency makes the imports look attractive to the nationals increasing the demand for imports. Consequently, the higher volumes of imports and lower volume of exports causes a decline in the trade surplus. In Summary, a country losses when its currency appreciates since its citizens prefer to import goods while the buyers from other nations prefer the competitor’s products.
When a country’s foreign currency appreciates, who benefits and who loses when a country’s currency depreciates who benefits and who loses?
In the event of the appreciation of a country’s foreign currency, the foreign buyers benefit while the local sellers lose. At the same time, when the foreign currency depreciates, the country benefits since it makes more foreign sales in comparison to its competitors. On the other hand, the foreign countries lose since their local buyers prefer the foreign products and shun local products.
In the end, what are the major factors that affect exchange rates?
Inflation: Exports become competitive and so their demand raise countries with lower inflation rates and vice versa.
Interest rates: Higher interest rates cause appreciation while lower interest’s rates cause depreciation
Understanding central banks impact exchange rates select three central banks and demonstrate/ explain how this occurs.
Understanding the central banks is crucial as study reveals that the central bank interventions have a significant effect on the heterogeneity at a monthly horizon. Consequently, the central bank's intervention move market opinions in different ways. The American central bank structure is mainly determined and shaped by the American history, especially the experiences with the first banks of the U.S and later the great depression. The bank's structure upholds diverse regional voices while still upholding the values of cooperative consensuses. Based on this understanding, investors have an idea of what to expect and about the exchange rate prediction.
Similarly, some central banks can be unpredictable when it comes to data publication. Case in point some make changes in the time they change data. Case in point the Canadian Central Bank announced they would update the delivery time of the 26 currencies they trade in stating 1 st May 2017. The changes would be made at 1630 Canadian time. Understanding the time and operations helps investors. At the same time, the back has a 1% policy interest rate and that is vital knowledge for investors.
On the other hand, the Bank of England, which is the central bank of the United Kingdom, has a core value of maintaining financial and monetary stability. Consequently, investors can use this premise to predetermine the exchange rates in the bank (Baillie & McMahon, 2009).
References
Adamson, R. K. (1941). A comparison of the determinants of foreign exchange rates and their effects on free and managed foreign exchange systems . Hoboken, N.J: J. Wiley.
Baillie, R., & McMahon, P. C. (2009). The foreign exchange market: Theory and econometric evidence . Cambridge [Cambridge shire: Cambridge University Press.
Clark, E., & Ghosh, D. (2004). Arbitrage, hedging, and speculation: The foreign exchange market . Westport, Conn. [u.a.: Praeger.
Homaifar, G. (2004). Managing global financial and foreign exchange rate risk . Hoboken, N.J: J. Wiley.
Yu, L., Wang, S., & Lai, K. K. (2007). Foreign exchange rate forecasting using artificial neural: Networks . Boston, ma: Springer.
