Factors that affect exchange rate

Topics: Foreign exchange market, Exchange rate, Bretton Woods system Pages: 4 (1186 words) Published: October 17, 2014
Factors that affect exchange rates.
Like any price, the exchange rate deviates from the cost basis - the purchasing power of currencies – under the influence of supply and demand of currency. The ratio of the supply and demand depends on several factors. It reflects connections with other economic categories - cost, price, money, interest, balance of payments, etc. There is a complex of interweaving and nomination of decisive factors. Among them are the following. • 1.The rate of inflation. The ratio of currency in their purchasing power (purchasing power parity) serves as a kind of axis of the exchange rate reflecting the law of value. That's why the rate of inflation has an impact on the exchange rate. All other things being equal, the inflation rate in the country has inversely proportional impact on the value of national currency, i.e. an increase in inflation in the country leads to a reduction in the national currency, and vice versa. Inflationary depreciation of money in the country reduces the purchasing power and a tendency to a drop in their currency's exchange rate against currencies of countries where the rate of inflation is lower. Alignment of the exchange rate and adjustment to purchasing power parity are occurred within two years. This is because the daily quotation of exchange rates is not corrected on the basis of their purchasing power, and there are other factors of forming of exchange rates.

• 2.The balance of payments. Balance of payments directly affects the value of the exchange rate. Thus, the active balance of payments improves the national currency as the demand from foreign debtors increases. The passive balance of payments leads to a tendency to a decrease in the national currency's exchange rate as domestic debtors try to sell everything using a foreign currency to repay their external obligations. The size of the impact of balance of payments on the exchange rate is determined by the degree of openness of the economy. Thus,...
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