Exchange rates change

Full Answer Section

   

• Economic growth: Faster economic growth in one country relative to another will make its goods and services more attractive to foreign buyers and cause the exchange rate to appreciate.
• Current account balance: A current account surplus in one country relative to another indicates that it is exporting more goods and services than it is importing, which will cause the exchange rate to appreciate.

Non-economic factors

• Political events: Major political events, such as elections or wars, can have a significant impact on exchange rates.
• Speculation: Currency traders may speculate on the future direction of exchange rates and buy or sell currencies accordingly, which can cause exchange rates to fluctuate in the short term.

Disadvantages of flexible exchange rates Flexible exchange rates offer a number of advantages, such as allowing countries to adjust their economies to external shocks and making it more difficult for speculators to manipulate exchange rates. However, there are also some disadvantages to flexible exchange rates, including:

• Volatility: Flexible exchange rates can be volatile, which can make it difficult for businesses to plan and invest.
• Uncertainty: The uncertainty about future exchange rates can discourage foreign investment and trade.
• Risk: Businesses that engage in international trade and investment are exposed to exchange rate risk, which can reduce their profits or even lead to losses.

Overall, flexible exchange rates offer a number of advantages and disadvantages. Countries must weigh the pros and cons carefully when deciding whether to adopt a flexible exchange rate regime. How to mitigate the disadvantages of flexible exchange rates There are a number of things that businesses and governments can do to mitigate the disadvantages of flexible exchange rates, such as:

• Hedging: Businesses can use hedging strategies to protect themselves from exchange rate risk. For example, a business that exports goods to another country can buy forward contracts to lock in the exchange rate for future payments.
• Diversification: Businesses can diversify their operations and markets to reduce their exposure to exchange rate risk. For example, a business can export goods to a variety of different countries to reduce its reliance on any one country.
• Government intervention: Governments can intervene in the foreign exchange market to stabilize the exchange rate. For example, a government can buy or sell its own currency to influence the exchange rate. However, government intervention can be expensive and can distort the market.

Conclusion Exchange rates change constantly, due to a variety of economic and non-economic factors. Flexible exchange rates offer a number of advantages, but they also have some disadvantages, such as volatility, uncertainty, and risk. Businesses and governments can mitigate the disadvantages of flexible exchange rates by using hedging strategies, diversifying their operations, and intervening in the foreign exchange market.  

Sample Answer

   

Exchange rates change constantly, 24 hours a day, 7 days a week. The factors that can influence exchange rates are many and complex, but they can be broadly divided into two categories: economic and non-economic factors.

Economic factors

• Interest rates: Higher interest rates in one country relative to another will attract foreign investment and cause the exchange rate to appreciate.
• Inflation: Higher inflation in one country relative to another will make its goods and services more expensive and less competitive, causing the exchange rate to depreciate.