Readers Questions – Explain how exchange rates are determined ?
(20) Exchange Rates are determined by supply and demand side
factors. For example, Increased demand for sterling will cause
an appreciation in the Sterling exchange rate. These are some of
the most significant factors in exchange rate determination: 1.
Interest Rates. If interest rates increase in the US then it
becomes relatively more attractive to save money in US banks and
in US bonds. Therefore, there is higher demand for US dollars
(to be able to buy the securities). This causes an appreciation.
– It is known as hot money flows. 2. Relative inflation Rates.
If US inflation was to become higher than other countries, US
goods would become less competitive. Therefore, there would be
less demand for US goods and US dollars, causing a depreciation.
General productivity and competitiveness will also have an
influence on the exchange rate. 3. Balance of Payments. If a
country has a large current account deficit it means it is
importing more goods a