Abdullah Hashmi (18016)
Table of Contents
1.1What is exchange rate?3
1.2 Floating exchange rate function.3
1.3 How exchange rate effect imports and exports?3
1.1What is exchange rate?
Exchange rate is the currency rate between two countries that is the price of one country currency is expressed in terms of another countries currency. For instance the rate of USD against PKR is, $1=97.7PKR. We have expressed exchange rate against USD because it is globally used for international transactions. The major types of exchange rate are; 1. Fixed/pegged exchange rate;
2. Flexible/floating exchange rate.
In a fixed exchange rate system there is government intervention in the currency market so that the exchange rate stays near to an exchange rate target. In it, the rate of exchange of currency is fixed in terms of gold or another currency. For example GCC (Gulf Cooperation Council) have agreed to establish a monetary union by 2010 with a single currency pegged to the U.S. dollar. 1.2 Floating exchange rate function.
In Pakistan floating exchange rate is used for the international transactions. In it, the government does not actively intervene in the currency markets to achieve a desired exchange rate level. In a country where floating exchange rate is followed the exchange rate market is determined by the demand and supply for a particular currency relative to the other currency. Therefore there are fluctuations on the exchange rate and it moves freely according to the demand and supply of that particular currency. Refer figure 3. 1.3 How exchange rate effect imports and exports?
As discussed earlier exchange rate is the value of one currency in terms of other currency, payments and receipts are in USD of exports and imports. So if the exchange rate is high then the trade deficit increases. If you are exporting and your local currency becomes strong then your products become more expensive for your buyers. If you are importing and your local currency becomes weak then the products you are importing become more expensive.
2. Research paper related to the research topic
Research was conducted by Marilyne Huchet-Bourdon, Jane Korinek to find the extent the exchange rates and their volatility affect trade. In this research the researchers found the impact of exchange rate on bilateral trade in three large economies, United States, China and Euro Area. The analysis was done in the context of a very large body of existing literature which motivated many of its methodology, many of the results were confirmed by it that were found in literature. It was found that the impact of exchange rate was minimal at the sectoral level. It was seen that exchange rate volatility between large economies like China, USA and Euro Area does not seem to be driving trade flows. This analysis confirms that much of the existing literature in the shortrun affects of the exchange rate on trade is limited. This analysis has not confirmed the existence of short-run J Curve; however, it talks about long-term J Curve interpretation as proposed by Yellen (1989) who found short-run devaluation followed by improvement in the long-run. Therefore, it was preferred to center future analysis on long-term chattels of exchange rate levels on trade. US have a stronger long-run affect on exchange rate as compare to Euro Area. In US-China trade there was 10% depreciation found in US $ this led to a 13% increment in US trade deficit in 2008. In this bilateral trading model of US, china an Euro Area, a depreciation of 10% was seen in US $ against Yuan because China was using pegged exchange rate in trading with US in the study. On the other hand, there were less significant results found in...