8. Exchange Rate Systems

What is an Exchange Rate

The price of one currency in terms of another

What is a Floating Exchange Rate

The price of one currency compared to another determined by the forces of demand and supply in a forex market

What is a Fixed Exchange Rate

When one currency is pegged to another currency (set in value to the other)

Maintained by regular intervention from authorities

What is a managed exchange rate

An exchange rate determined by the market forces of supply and demand in a forex market with periodic intervention by authorities

Floating Exchange Rate Diagram

What are the supply and demand curves of a floating exchange rate diagram representing

Supply Curve: Anyone that has said currency who also want to sell said currency

Demand Curve: Anyone who doesn’t have/doesn’t have enough said currency at the moment that want said currency

What leads to an appreciation and a depreciation of a currency (in terms of supply and demand)

Appreciation - Increase in Demand and Decrease in Supply

Depreciation - Decrease in Demand and Increase in Supply

Factors that Appreciate a Currency

Increased Export Demand

Decreased Import Demand

Increased Interest Rates

Inward FDI

Speculation

High Confidence

Quantitative Tightening - Decreases Supply of Money

Factors that Depreciate a Currency

Increasing Import Demand

Decreasing Export Demand

Decrease of the Interest Rates

Outward FDI

Speculation

Low Confidence

QE - Increase in the money supply

How can Central Banks Intervene to Influence the Exchange Rate

Interest Rates - Manipulating Hot Money Flows to influence the demand for the currency

Increase Domestic Currency Reserves and Decrease Foreign Currency Reserves to Appreciate the Exchange Rate

Decrease Domestic Currency Reserves and Increase Foreign Currency Reserves to Depreciate the Exchange Rate