Can someone explain exchange rates..? (1 Viewer)

[SophJI]

I don't get how BOP links with exchange rates

and how exchange rates are determined..?

anyone? plz......!

 

[jack_smith]

supply and demand of each currency.

equilibrium = exchange rate silly.

 

[aznvdz]

A floating exchange rate fluctuates according to demand and supply.
Demand for the $AUD will increase because of incresed exports, Australians borrowing from overseas and increasd investment in Australia. This will result in the exchange rate to be higher as demand is increased.

Fixed exchange rates are determined by the government.

Both have advantages and disadvantages.

 

[gnrlies]

I don't get how BOP links with exchange rates

and how exchange rates are determined..?

anyone? plz......!

There are some interesting links between the BOP and fixed currencies because there wont necessarily (in fact it is unlikely) be a "balance".

historically when currencies were backed by gold, there would need to be a 'specie' inflow (i.e. gold would have to come into the country) in order to maintain the balance of payments whilst maintaining a currency fixed to the value of gold. Under a floating system the currency automatically adjusts to maintain a balance but with the gold standard, this mechanism is not present. Central banks would need to make adjustments in the money supply (which implies changes in gold reserves) in order to maintain balance. This makes sense because if a country is spending more than it can afford, then it will require more money to do so, and will need to increase the money supply. The only way it can increase the money supply is by increasing the amount of gold reserves.

Now the gold standard is not the same thing as a fixed exchange rate, however the example is analogous. The bretton woods system required the US dollar to be backed by gold, with all other currencies being fixed to the US dollar which meant that implicitly these currencies were backed by gold. So without the ER fluctuating to maintain balance, central banks would have to bring in an appropriate amount of reserves (which replaces gold).