MACRO 14
EXCHANGE RATES
The exchange rate is the purchasing power of a currency in terms of
what it can buy of other currencies
Bilateral exchange rates are the exchange rates between two
distinct currencies
o £/ $
Less X-M leads to less demand for pound and pound depreciates
Exchange rate index
Gives pounds value against basket of currencies
Weighted against proportion of trade UK does with each country
Heavily weighted currencies
o Euro and dollar
Gives indication of the overall strength or weakness of UK currency
in forex markets
o Forex markets are global currencies
Y axis is anything but price
, X axis is quantity on ForEx markets
What causes exchange rate to move
Changes in demand supply
Factors that cause shifts in demand and supply are more important
Balance of payments
Large current account deficit means value of imports is greater than
value of exports
Leads to depreciation of currency
o Less demand for exports leads to less demand for currency
Current account deficit one of the reasons for weak performance of
the pound in 2008
Inflation
Inflation lower in UK than elsewhere
UK exports more competitive and increase in demand for pounds
Foreign goods less competitive and UK citizens supply fewer pounds
to buy foreign goods
Rate of pound tends to increase
Change in competitiveness
If UK goods were more competitive it also causes exchange rate to
rise
Important for determining long run value of pound
Often referred to as long term fundamental factors that determine
an exchange rate
Short term other factors come into plat and are sometimes more
important
Interest rates
If UK interest rates rise relative to elsewhere it becomes more
attractive to deposit money in UK
Demand for pound will rise
Known as hot money flows
EXCHANGE RATES
The exchange rate is the purchasing power of a currency in terms of
what it can buy of other currencies
Bilateral exchange rates are the exchange rates between two
distinct currencies
o £/ $
Less X-M leads to less demand for pound and pound depreciates
Exchange rate index
Gives pounds value against basket of currencies
Weighted against proportion of trade UK does with each country
Heavily weighted currencies
o Euro and dollar
Gives indication of the overall strength or weakness of UK currency
in forex markets
o Forex markets are global currencies
Y axis is anything but price
, X axis is quantity on ForEx markets
What causes exchange rate to move
Changes in demand supply
Factors that cause shifts in demand and supply are more important
Balance of payments
Large current account deficit means value of imports is greater than
value of exports
Leads to depreciation of currency
o Less demand for exports leads to less demand for currency
Current account deficit one of the reasons for weak performance of
the pound in 2008
Inflation
Inflation lower in UK than elsewhere
UK exports more competitive and increase in demand for pounds
Foreign goods less competitive and UK citizens supply fewer pounds
to buy foreign goods
Rate of pound tends to increase
Change in competitiveness
If UK goods were more competitive it also causes exchange rate to
rise
Important for determining long run value of pound
Often referred to as long term fundamental factors that determine
an exchange rate
Short term other factors come into plat and are sometimes more
important
Interest rates
If UK interest rates rise relative to elsewhere it becomes more
attractive to deposit money in UK
Demand for pound will rise
Known as hot money flows
