# Appreciation and Its Effects on Interest and Exchange Rates

Pages: 3 (1102 words) Published: October 2, 2013
1.Explain the how appreciation affects interest rates and exchange rates. How does this influence commodity currency? Should we return to a gold standard? Why or why not? Business dictionary defines an exchange rate as the rate at which one currency can be exchanged for another. In other words, it is the value of another country's currency compared to that of your own. If you are planning a trip to travel abroad this is something that needs to be calculated along the trip, because in order to purchase goods or services while aboard one would need to “purchase” the local currency. Just like the price of any asset, the exchange rate is the price at which you can buy that currency. If you are traveling within Europe, for example, and the exchange rate for U.S. dollars is 1:0.75 Euro, this means that for every U.S. dollar, you can buy \$0.75 Euros. Theoretically, identical assets should sell at the same price in different countries, because the exchange rate must maintain the inherent value of one currency against the other.

There are two ways the price of a currency can be determined against another. A fixed rate is a rate the government or in most cases the central bank sets and maintains as the official exchange rate. A set price will be determined against a major world currency. The most common currency countries usually fix to is the U.S. dollar. The local exchange rate is maintain by the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged. According to Xu unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand. A floating rate is often coined "self-correcting," as any differences in supply and demand will automatically be corrected in the market. Look at this simplified model: if demand for a currency is low, its value will decrease, thus making imported goods more expensive and stimulating demand for local goods and services....

Cited: Frankel, Jeffrey 2006: On the Yuan. The Choice between Adjustment under a Fixed ExchangeRate and a Flexible Exchange Rate.
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McKinnon, Ronald / Schnabl, Gunther 2006: Devaluing the Dollar: A Critical Analysis of William Cline’s Case for a New Plaza Agreement. Journal of Economic Policy Modeling