Policies that Affect Exchange Rates

Introduction

What can effect the Exchange Rate?

Changes in a nation’s monetary and fiscal policies affect its exchange rates and its balance of trade through their effect on the real interest rate, income, and the price level. Changes in the value of a country’s currency affect the balance of trade, which affect aggregate demand. Changes in aggregate demand affect real output and the price level. In other words, domestic policies influence currency values, and currency values influence domestic policies.

Policy makers cannot ignore the international effects of changes in monetary and fiscal policies.

Fix or Float?

Learn more in the activity below.

In a free-floating exchange rate system, exchange rates are determined by demand and supply.
Exchange rates are determined by demand and supply in a managed float system, but governments intervene as buyers or sellers of currencies in an effort to influence exchange rates.
In a fixed exchange rate system, exchange rates among currencies are not allowed to change.

Watch the presentation below to learn more about exchange rate policies.

Review

Review what you have learned by completing the activity below.

In Summary . . .

What's Your takeaway? Icon For this module, we focused on the foreign exchange market and examined how the equilibrium exchange rate is determined. We should understand how market forces and public policy affect currency demand and currency supply in the foreign exchange markets and lead to currency appreciation or depreciation. How financial capital flows affect exchange rates, and how appreciation or depreciation of a currency affects a country’s exports and imports should be an integral part of the presentation. Having learned the mechanics of the foreign exchange markets, we should then understand how changes in net exports and financial capital flows affect financial and goods markets.

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