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Factors Driving Changes in Exchange Rates

Analyse the causes of an increase in a country’s exchange rate.

Category:

International Trade and Exchange Rates

Frequently asked question

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Answer

Avoid excessive direct quotes and paraphrase information instead.

An increase in a country's exchange rate can be influenced by various factors. Let's analyze these causes:
➡️1. Change in market conditions for a floating exchange rate: In a floating exchange rate system, market forces determine the value of the currency. An increase in the exchange rate can occur due to shifts in market conditions, such as changes in supply and demand dynamics. For example, if the country's economy strengthens, leading to increased confidence among foreign investors, there may be a higher demand for the country's currency, resulting in an appreciation of the exchange rate.
➡️2. Increase in demand for the currency: An increase in the demand for a country's currency can lead to an appreciation of the exchange rate. Factors that can contribute to increased demand include improved export competitiveness, where the country's exports become cheaper or of higher quality, attracting more foreign buyers. Additionally, higher interest rates in the country may attract foreign investors seeking better returns on their financial investments. Speculation that the currency's value will continue to rise can also drive up demand.
➡️3. Decrease in supply of the currency: A decrease in the supply of a country's currency can contribute to an increase in its exchange rate. This can occur when the country experiences higher import costs, poorer quality imports, or implements trade barriers that reduce the demand for imports. Lower interest rates may also discourage foreign investors from holding the currency, leading to a decrease in its supply.
➡️4. Government decision to raise the value of the currency: In some cases, the government may intervene in the foreign exchange market to influence the value of its currency. For countries with a fixed exchange rate system, the government can adjust its currency's value by buying or selling it in the foreign exchange market. By raising the value of the currency, the government aims to promote import competitiveness, reduce inflationary pressures, or address trade imbalances.
It's important to note that the causes mentioned above are not exhaustive, and the exchange rate can be influenced by a combination of economic, political, and market factors. Additionally, the impact of exchange rate changes on the country's economy can be complex, with both positive and negative effects on various sectors, such as exports, imports, investment, and inflation.

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I. 🍃Introduction
- Explanation of the topic
- Purpose of the outline

II. Change in market conditions for a floating exchange rate
- Definition of floating exchange rate
- Increase in demand for the currency
- Cheaper exports/higher quality exports
- Greater demand for exports
- Higher interest rates may increase demand for financial investment
- Speculation that the currency may rise further
- Decrease in supply of the currency
- More expensive imports/poorer quality imports/trade barriers
- Lower demand for imports
- Lower interest rates may cause inward financial investment (hot money) to fall

III. Government decision to raise the value of the currency for a fixed exchange rate
- Definition of fixed exchange rate
- Reasons for government decision
- Effects on the economy
- Advantages and disadvantages of fixed exchange rate

IV. 👉Conclusion
- Summary of the main points
- Implications for the economy
- Future outlook for the currency exchange rate.

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• Change in market conditions for a floating exchange rate -
• Increase in demand for the currency - cheaper exports/higher quality exports - may lead to greater demand for exports - higher interest rates may increase demand for financial investment - there may be speculation that the currency may rise further -
• Decrease in supply of the currency - more expensive imports/poorer quality imports/trade barriers - may lead to lower demand for imports - lower interest rates may cause inward financial investment (hot money) to fall -
• Government decision to raise the value of the currency - for a fixed exchange rate -

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