Macroeconomic factors that influence the exchange rate | Sponsored | state-journal.com – State-Journal.com

For a variety of reasons, a central bank will be worried about the fluctuation and changes in the exchange rate. The first is that changes in the exchange rate have an impact on the amount of aggregate demand in a given economy. The second factor is that exchange rate volatility can deter the international trade of one country with another and cause problems in the national banking system. which has the ability to result in the usability of trade balance or the larger capital income from the foreign countries. It might cause an economic recession if the foreign investors come to the conclusion to take their capital to another country. 

Exchange rates, demand, and supply 

Foreign trade means that one country is producing goods and services at the cost of production in one currency, while the revenues are received in the other country’s currency. This is why the exchange rates have an impact on the export and import and in general, on the whole economy. Due to the fact that a rise in exports results in more dollars coming into the country, a rise in imports results in more dollars flowing out of the country. It is simple to assume that exports are having a positive impact on the economy and imports are having negative effects, however, it undermines the importance of the exchange rate. 

Those who make purchases in dollars must spend them on American products and services, ensuring that the money stays in the country. At the same time, the consumer saves money by purchasing a lower-cost import and may put the money toward other things. 

Exchange rate fluctuations 

Exchange rates can be changed at a high rate even in a short period of time. A very good example, in this case, is the Indian rupee, which fell from 39 rupees to 51 rupees per dollar which was a drop of more than one-fourth in the rupee’s value in the foreign exchange markets. Even stable economies that are neighboring countries such as the US and Canada can have fluctuations in exchange rates for a longer period of time. Sharp variation in exchange rates can cause large changes in earnings and losses for enterprises that rely on export sales, import inputs to manufacturing, or even solely local enterprises that compete with enterprises who are related to international trade, in many countries which accounts for half or more of a country’s GDP. 

In some cases, central banks might want to keep exchange rates from fluctuating to create a stable environment for business activities, where the companies would have a lot of opportunities for productivity and innovation, without the impact of the exchange rates. The exchange rate also largely defines how the Forex market works since the whole market is dependent on the fluctuations and changes between currency pairs. The banking system can be one of the most economically damaging impacts of exchange rate changes. Most overseas loans are assessed by financial institutions in a few significant currencies such as US dollars, European euros, and Japanese yen. In nations where these currencies are not used, banks frequently borrow cash in other nations’ currencies, such as US dollars, but then lend in their own domestic currency. The left-hand events chain demonstrates how these international borrowing patterns might operate. A Thai bank takes out a one-million-dollar loan. 

The bank then changes the dollars to the local currency, which in Thailand is the baht, at a rate of 40 baht per dollar. The baht is then lent by the bank to a Thai company, the company repays the debt in baht, which the bank then translates back to US dollars to pay off the initial debt.

International borrowing

The foreing borrowing scenario on the left is a success story, while the scenario on the right demonstrates what occurs when the currency rate drops. As long as the exchange rate does not change, this practice of borrowing in a foreign currency and lending in a home currency can function just well. An issue occurs in the scenario stated if the dollar gains while the baht declines. 

The right-hand events chain shows what happens when the baht falls from 40 to 50 baht/dollar abruptly. The Thai company continues to reimburse the bank which on the other hand is unable to repay its loans in US dollars due to the changes and fluctuations in the exchange rate. Countries in eastern Asia, such as Thailand, Korea, Malaysia, and Indonesia, had their currencies depreciate by as much as 50% at the end of the 20th century. These nations had been seeing significant inflows of foreign investment money, with bank lending growing by 10 % per year. This is when the banking system went bankrupt. Banks are essential authorities in any economy because they facilitate transactions and provide loans to businesses and individuals. When the majority of a country’s main banks fail at the same time, aggregate demand plummets, resulting in a significant recession. 

Summing It Up 

Every country wants a stable exchange rate because it facilitates international trade and reduces economic risk and uncertainty. A country may, however, seek a lesser exchange rate to boost aggregate demand and avoid a recession, or a stronger exchange rate to combat inflation. 

Quick fluctuations from a weak to a more stable exchange rate might harm the country’s export sectors, and vice versa, rapid changes from a strong to a weaker exchange rate may harm the banking sector in general. In other words. Every decision about whether an exchange rate should be stronger or it should become weaker, constant or changing, reflects possible tradeoffs. 

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