A Country Exchange Rate Plays A Major Role In Its Economy Economics Essay


For a state exchange rate plays a major function in its economic system. In this paper we will discourse about assorted exchange rates and how it is helpful in international trade. We will besides discourse the differences in assorted exchange rates and happen a solution whether all states should follow a fixed exchange rate or non?

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An exchange rate is a rate at which one states currency can be traded in another foreign states currency. There could be many grounds for which states have fixed exchange rate such as

Rate of rising prices between both the states

The involvement rates of both the states

Demand and supply between both the states

Government intercessions in exchange market.

Fixed exchange rate:

The rate at which a states currency is matched with another states currency or a group of currencies or a standard such as gold. This is besides called as pegged exchange rate. By nail downing two currencies together it is easy for trades and investings. It can besides assist to command rising prices for a state.

There are several theories involved in the exchange rate system such

Buying power para ( PPP )

Interest rate para ( IRP )

International fisher consequence ( IFE )

Let us now discuss about each of these theories in item

The buying power para ( PPP ) focuses on the rising prices of exchange rate relationships. There are two types of PPP called as absolute and comparative buying power para. The absolute PPP we can see that the exchange rates between currencies of two states is equal to ratio of monetary values in both the states for illustration if a merchandise A has monetary value X in a state, so the monetary value in state B must besides be the same.

The comparative PPP exchange rates over a period of clip should be relative to the alterations in monetary value over the same clip period. This theory accepts that the monetary values of the merchandise will non needfully be the same in different states when measured with a common currency.

If we want diagrammatically analyze so on the x-axis the depreciation in foreign currency is taken and on y-axis the place currency is taken. This measures the per centum which says rising prices is higher or lower.

The involvement rate para ( IRP ) says that the forward rate of one state with regard to another has a premium or a price reduction which can be determined by different involvement rates between the both the states.

In the international fisher consequence ( IFE ) the topographic point rate of one currency will alter in conformity to involvement rates of the both the states. It is closely related with PPP because the involvement rates are strictly correlated with rising prices rates.

Floating exchange rate:

This is another sort of exchange rate where the currency valued is ever fluctuating and is non changeless ever. The currency which uses this sort of exchange is called as natation currency. This sort of exchange rate is non used by all states as the currency is non stable and there are many jobs like rising prices may be excessively high.

So, this is a brief treatment about exchange rate and the theories related to the exchange rate.

Part B:

Business certainty in international trade:

International trade is the exchange of goods and services across different states. Industrialization, transit, globalisation, MNC ‘s, outsourcing will hold a major impact on international trade. International trade is a major beginning of a state ‘s economic power. Without international trade the goods and services would non travel beyond the boundary lines. International trade is non different from domestic trade, but it has merely a few differences like international trade is more dearly-won, trade duties, boundary line issues and societal factors.

Another difference between domestic and international trades is the production costs and factors. There should be many factors in international trade such as trade limitations in goods and services. The production costs for any merchandise in a state could be high when compared to another state because of high stuff costs. For illustration electronics fabrication could be dearly-won in UK when compared to china. So both the states can follow international trade form in cut downing costs and increasing net incomes.

Differences between fixed exchange and drifting exchange rates:

In a fixed exchange system the authorities interferes in the exchange market because the present exchange rate is closer to the current currency mark. For illustration when Britain joined the European Union the lb sterling was fixed with EU currency, to keep the mark which skiding by 6 % on both the sides the lb could non prolong the merchandising force per unit areas as a consequence of which it left the European rate mechanism in 1992. Since fall 1992 UK had a floating exchange rate.

With floating exchange rates there could be a alteration in demand and supply. In the above graph of the state. This led to a rise in currency demand which leads to appreciation in market value.

In the above graph we can see that there is a rise in currency supply which besides creates jobs sometimes. Here the currency supply s1-s2 leads in the depreciation in the market value. So this is a graphical representation of differences between fixed and drifting exchange rate.

Professionals and Cons of fixed exchange rate:


Creates a great stableness in international trade since the exchange rates do non alter and the investors can make more imports and exports without any depreciation or grasp.

This helps the manufacturers to minimise their production costs and better quality and remain as a competition to international markets.

It could diminish rising prices and increase the economic growing and international trade in the long tally.


It has high exposure of economic system to speculative onslaughts.

Government unnaturally supports the exchange rate system where it could non alter the exchange rate of the currency when the state ‘s economic system is efficient.

The involvement rates could non alter as they depend on the exchange rate so economic growing could be low.

Example of fixed exchange rate:

There is a simple illustration to explicate the fixed exchange rate when there was a fiscal crisis in Asia in 1997. The Chinese and the Malayan currencies were in problem, so the Chinese fixed their currency and Malayans pegged their currency to US dollar which helped them to resuscitate their economic lucks. The states which adopt fixed exchange government should be careful about their policies involved. They should hold a just assurance in their international markets or else the full system could take to a failure. They need to hold a perfect program when they have moved into the fixed exchange government. The authorities will purchase currencies of other states in unfastened fiscal markets to get down the full procedure. When the exchange rate goes down the authorities purchases their ain currency with their militias. These additions in the demand of them ain currency and the exchange rate and besides the demand for the currency additions. In certain conditions the state of affairs could be improper where the authorities has to sell the currency in a low rate. There could be many grounds like black selling of currency, so authorities should take necessary control over this government like China in 1990 when the authorities took complete clasp over its currency where its currency was fixed to US dollar.

Ought all states to follow a fixed exchange rate?

Well, after looking at assorted scenarios of the assorted exchange rates we can state that it is good to follow a fixed exchange rate for all states as the rising prices would be low, there would be increase in economical growing and international trade.

In concern the production costs may diminish and the quality additions which would increase international trade. So if all states have a fixed exchange rate their economic growing would increase and besides the exchange rate for their currency would be good.


With all the factors and illustrations of assorted states into consideration we could state that if the exchange system is fixed or pegged to another state ‘s currency at that place would be economic growing and international trade would increase.


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