The paper "Factors Which Can Influence Exchange Rate Movements " is a good example of a finance and accounting coursework. The exchange rate is the price of a country’ s currency expressed in terms of another currency. The two countries most probably have trading relations. The exchange rate in a way is used to determine the economic strength of a country by measuring the value of the countries currency. The exchange rate is influenced by several factors chief among them interest rates and economic conditions (Tauline, 2008). It is vital that the value of a country’ s currency is maintained as high as appropriate depending on the prevailing conditions or as low as necessary depending on the desired outcome.
The central banks all over the world are tasked with ensuring exchange rate stability in their respective economies through various strategies (Nier, 2009). This paper is intending to discuss several factors influencing exchange rates and also strategies adopted by the Reserve Bank of Australia in the foreign exchange market in comparison to those adopted by the Federal Reserve of the US. Factors which can influence exchange rate movements Interest rates Over the past few years, interest rates have emerged as a very important factor that influences interest rates in countries’ economies.
There exists an interrelated relationship between interest rates, inflation and exchanges rates. Central banks manipulate interest rates to influence inflation rates and exchange rates. A higher interest rate in a country in relation to other countries will mean that the investors in that particular country are earning a higher return on their deposits than in the country with a lower interest rate. The implication of this is a higher demand for the currency of the country with the higher interest rate causing the exchange rate of that country to rise.
On the other hand, lower interest rates will decrease exchange rates. Central Banks use this technique to influence the exchange rates in order to achieve desired economic performance depending on the prevailing conditions of the respective economies (Ellis, 2001). Balance of payments Balance of payments is a summary analysis of a country’ s trade with its trading partners. It covers tangible goods and services that a country exports and imports as well as the financial transactions between the country and the world countries.
It has the potential of influencing the macro and microeconomic operations of the country. When a country exports goods or receives foreign investment in the form of foreign currency it has to transform the foreign currency into the domestic currency for it to be allowed to circulate. This scenario increases the supply of foreign currency in the market. This means the exchange rate is high. If a country on the other hand imports or experiences massive outflow of investment, it will result in foreign payments.
The country is forced to convert the domestic currency into foreign currency. There is an increased demand for foreign currency in the market. The increased demand will lower the exchange rate. Since the demand for foreign currency is high but its supply remains constant and vice-versa for increased supply of foreign currency (Ellis, 2001). Political environment Politics most definitely affect every sphere of life in a country. The economy of a country is closely linked to its political situation; countries with thriving economies will also reflect a high level of economic stability.
A country with an unpredictable political environment is very likely to experience irregular inflow and outflow of currencies especially when it comes to foreign investment. Investors are unlikely to channel their money into a country that shows signs of deteriorating into unmanageable political situations; instead, they will choose to invest in a country with a stable and predictable political environment which also affects its macro and microeconomic situation. The result will be a low supply of foreign currency in the country with an unstable political environment and therefore a low exchange rate.
Unstable political environment will also reduce the productivity of an economy meaning the level of exports will reduce and as such reduce the foreign currency being earned by the exports which will, in turn, lower the exchange rate (Tauline, 2008).
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Ellis, L. (2001). Measuring the Real Exchange Rate: Pitfalls and Practicalities. Reserve Bank of Australia, Research Discussion Paper.
Nier, E. (2009). Financial stability Frameworks and the Role of Central Banks: Lessons from the Crisis. International Monetary Fund.
Tauline, M. J. (2008). Exchange Rates: Dynamics, Expectations and Adjustment. Nova Science Pub Incorporated.