IB econ - 16.1 Floating exchange rates

Define foreign exchange

refers to units of foreign currency

define exchange rate

The rate at which one currency can be exchanged for another, or the number of unit sof foreign currency that correspond to the domestic currency

define a floating (flexible) exchange rate system

an exchange rate system where exchange rates are determined entirely by market forces, no intervention

what are the axis labels for the market of x dollar to the USD

y = exchange rate x/$

x = qty of x

where does demand for foreign currencies come from and examples

foreigners looking for that currency to carry out transactions

- importers to pay people with their own currency

- investors wanting to invest in that zone/country/region with that currency

- consumers going to holiday in the region

where does supply for foreign currencies come from and examples

from residents of the region looking to 'sell' their currency to then buy others

- people looking to buy goods from other regions

- people wanting to take a holiday in other region

- people planning to invest in a zone with different currecny

how is the equilibrium determined in a floating exchange rate system

determined by the forces of demand and supply at the point where the qty of a currency demanded equals qty supplied, without any gov or central bank intervention

what is an appreciation of a currency

An increase in the value of the currency using floating exchange rates, results from increase in demand or decrease in supply

what is a depreciation of a currency

a fall in the value of a currency in a floating exchange rate system, from decreased demand or increased supply in the absence of intervention

factors that influence demand of a currency

- foreign demand for exports of goods

- foreign demand for exports of services e.g. tourism

- inflation rate relative to other countries

- relative growth rates

- Inward Foreign direct investment and portfolio investment (FDI)

- relative interest rates

- inward flow of remittances

- speculation that a currency will appreciate

- CBA intervention to increase the value of a currency

factors that influence the supply of a currency

- domestic demand for imports of goods

- domestic demand for imports of services e.g. tourism

- rate of inflation relative to other countries

- relative growth rates

- outward foreign direct investment (FDI) and portfolio investment

- relative interest rates

- outward flow of remittances

- speculation that a currency will depreciate

- CBA intervention to decrease the value of a currency

factors that lead to appreciation - demand side

- increase in foreign demand for exports of goods and services

- lower inflation to increase foreign demand for exports

- high growth rates of trading partners leading to increase in foreign demand for exports

- increase in inward investment

- higher interest rates leading to more inward financial investment

- increase in inflow of investments

- increase in inflow of remittances

- speculators expect currency X will rise so they buy currency X

- CBA buys the domestic currency

factors that lead to appreciation - supply side

- decrease in domestic demand for imports of goods and services

- lower inflation leading to decrease in domestic demands for imports

- low domestic growth rate leading to decrease in domestic demand for imports