Floating exchange rate
In a perfect two country exchange system, the supply of one country’s currency is the demand for that currency from another country The price is determined by the simple and familiar supply and demand diagram.
Appreciation: Increase in value. Depreciation: Decrease in value
Change: Demand
- Exports and factors affecting exports
- Lower rate of inflation increases value.
- Interest rates: higher rates = more investment.
- Remittances: Transfer of money from one country to another.
Change: Supply
- Demand for imports = increase supply of currency
Effects on exchange rate
Will depend on which is stronger: import or export. There are also effects of changing exchanges rates. Appreciation will lead to decrease in net exports, and depreciation will lead to increase in net exports. They move the aggregate demand. Unemployment: the different sectors of the importing and exporting industries will matter.
Over & Under evaluation
Overvaluation makes imports cheaper, which is a good thing for developing nations. A deficit here is how exports are more expensive, hurting domestic exporters.