Exchange Rate Fluctuations | Economics for GCSE/IGCSE - Year 11 PDF Download

Causes of Exchange Rate Fluctuations

• Numerous factors influence floating exchange rates, leading to currency appreciation or depreciation.

Factors influencing floating exchange rates

• Changes in Relative Interest Rates: When the UK increases its interest rate, demand for £ by foreign investors rises, leading to £ appreciation. Conversely, a decrease in UK interest rates increases £ supply, causing depreciation.
• Changes in Relative Inflation Rates: Rising inflation in the UK compared to other countries makes UK exports costlier, decreasing foreign demand for UK products and causing £ depreciation.
• Impact of Net Investment: Foreign Direct Investment (FDI) boosts £ demand, resulting in £ appreciation. Conversely, UK firms' FDI abroad increases £ supply, leading to £ depreciation.
• Influence of the Current Account: UK exports require payments in £, while imports are paid in local currencies, necessitating £ supply in the forex market. Rising net exports appreciate £, while falling net exports depreciate £.
• Effect of Changes in Tastes/Preferences: For instance, as global demand for quinoa surged, Bolivia's quinoa exports increased significantly, strengthening their currency due to heightened demand.
• Role of Speculation: Currency trades based on predictions for short-to-medium-term value fluctuations influence exchange rates significantly.
• Impact of Quantitative Easing: By expanding the money supply, quantitative easing leads to £ depreciation as foreign investors exchange received £ for their own currencies.
• Influence of Multinational Corporations (MNCs): Increased MNC activities globally enhance cross-border money flows, impacting exchange rates.

Consequences of Fluctuating Foreign Exchange Rates

• Changes in exchange rates can significantly impact an economy.

The impact of changes to exchange rates on an economy