Exchange Rates

The value of a nation’s currency in terms of another currency i.e. £1=$2

An exchange rate is set by demand and supply of a currency

Floating Exchange rates

Floating exchange rates are determined by the interaction of demand and supply for a countries currency

Demand is determined by the need to purchase £ which is influenced by:

• Exports
• Investment
• Speculative demand

Supply is determined by the need of agents to use £ in place of their own currency its influenced by:

• Imports
• Outflows of investment
• Speculative selling of £s

Fixed Exchange rates

• Fixed exchange rates are where the rate for converting one currency into another is fixed
• Fixed exchange rates can be pegged to another currency and no fluctuations are allowed
• Pegged exchange rates allow for costs to be calculated easily
• You can also have semi-fixed exchange rates where the exchange rate needs to stay within set boundaries

Advantages of Floating Exchange Rates

• Value of the currency is determined by market forces
• There is no need for government / central bank intervention

Disadvantages of Floating Exchange Rates

• Can be difficult to predict costs
• Currency may be affected by volatile market conditions

Advantages of Fixed Exchange Rates

• Know what the exchange rate is so makes it easy to plan for the future
• A country can reduce costs and therefore increase competitiveness

Disadvantages of Fixed Exchange Rates

• Needs government intervention
• Can cause macro-economic problems keeping the exchange rate at a set rate
• May reduce stability of domestic economy