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What Might Cause An Appreciation Of A Floating Exchange Rate?

1775 words - 7 pages

What might cause an appreciation of a floating exchange rate?
Discuss whether an appreciation of a country's exchange rate will
always be beneficial to that country.

a) what might cause an appreciation of a floating exchange rate?

b) Discuss whether an appreciation of a country's exchange rate will
always be beneficial to that country. (15)

A free, fluctuating or floating exchange rate means the existence of a
free or competitive foreign exchange market where the price of one
currency in terms of another is determined by the forces of supply and
demand operating without any official interference.
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A rise in the price of a currency in terms of another currency is
called an appreciation.
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The following figure shows the equilibrium price of pounds in terms of
U.S dollars.

Short and long-term movements in the exchange rate, like any price,
are caused by changes in market demand and supply conditions. The
appreciation of a country's currency will occur due to either an
increase in demand or fall in supply of that currency.

The demand for sterling (pounds) in the FOREX markets comes from many
sources

UK goods and services are exported overseas - . if there is an
increase in exports this will create an inflow of currency into to the
UK which needs to be turned into sterling this will increase demand
for the sterling . When US consumers but British Whisky they supply
dollars and this is eventually translated into a demand for pounds.
This will cause an outward shift in the demand curve for sterling,
thus causing the currency to appreciate.

Foreign long term investment flows into the UK economy will again
increase the demand for the sterling for example, Pakistani investment
in a car plant in the UK will raise the demand for pounds causing an
outward shift of the demand curve. This will again cause the pound to
appreciate.

Interest rates have a large effect in a world where financial capital
can move freely between countries. An appreciation of the pound
sterling will occur when there are "hot money inflows". When a
country's interest rates are high relative to elsewhere this attracts
inflows of money into a country seeking to take advantage of the high
interest rates.When the interest rates of a country rise, savers
abroad may shift their saving funds from foreign banks to UK
banks.This "interest differential" boosts the demand for the currency
and can cause its value to rise. This is likely to be short term, as
savers will switch to different financial centers in search of the
highest interest rates in the world. This hot money inflow will be an
inflow increase in the capital account of the balance of payments.
This will increase the demand for the sterling shifting the demand
curve outwards and appreciating the pound.

Mere speculation can cause...

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