Impact of Exchange rate on economy and individuals
The market based exchange rate varies with respect to either of its components; currency raises its worth when the inclination of demand is higher than supply and loses its worth in reverse condition whereas the need of money is there, the preferred mean of wealth shifted to other currency or any other form, in case of transactions the demand for money has speculative increase which is strongly associated to GDP, business environment the employment level because the unfavorable condition of a region shrink the spending level and eventually central bank need to change the trend to adjust its need of money for business transactions which compels the bank to adjust its rate of interest if it is already high enough, sometimes it’s been speculated demand to hold the currency stable and it could be done with an artificial downward on currency, in short for taking profit the speculator could buy the currency back when it depreciates.
The worth of currency varies with its supply and demand same thing happens for purchase of imported products when the currency is strong like US-dollar, similarly when interest rate is upward it tend the people to invest in other securities, eventually this lead to trade deficit when dollar in a strong position whereas an opposite impact on exports. The worth of currency has a vivid impact on imports and exports and ultimately affects the economy, individual’s life in numerous ways. This rise and fall of the worth of currency is the reaction of the forces i.e. supply and demand which could be observed via foreign exchange rate in a particular region. The sour worth of currency diminish the people’s spending and business sentiments which is not possible in a boomed economy which is a pedestal of a strong currency and provide the governments intervene so that the other factors like inflation, interest rates, employment, governmental initiatives etc.
Fixed Exchange rate system:
According to the fixed exchange rate system the government is held responsible to maintain a fixed exchange rate for its domestic currency, under this regime the government announces both the par value and the band of exchange rates within which the exchange rate varies, the exchange rate announced by the government is known as the parity rate and in order to prevent the exchange rate from appreciation the government buys foreign currency in exchange for domestic currency this would result in an increase in the supply of the domestic currency on the other hand for the avoidance of depreciation of the domestic currency the government will buy the domestic currency using the foreign currency.
Real world example:
The world been pledged
It was a time when currency’s worth and exchange rate was associated with the gold i.e. 1870 to 1914, the gold standard was a provision for infinite capital mobility, trade and currency stability and it was vanished during world-war-1, so by the end of world-war-2, a deliberated rules were established for governing the international exchange rate and the result was IMF to propagate and maintain the monetary stability all over the globe.
Flexible Exchange rate regime:
According to the flexible exchange rate system the exchange rate is established through the forces of demand and supply for a currency vis-à-vis another currency, every nation in order to achieve its economic objectives chooses an exchange rate system.
Examples of countries following flexible exchange rate system are as follows:
1) The United States
2) The United Kingdom
3) Canada, Japan,
4) New Zealand and
These countries permit their currencies to float independently in the foreign exchange market and it is important to note that the exchange rate of these currencies is determined by the market forces. Under the flexible exchange rate system both the monetary and fiscal policies are not supposed to be subordinated to the need of defending the exchange rate and the supporting polices can be directed by the anchors like target inflation rate and target growth rate.
Revaluation of currency:
Under the fixed exchange rate system the increase in the value of currency relative to another currency is known as Revaluation of currency
During the period of 1970’s to 1990’s Turkey experienced a severe depreciation because of its hyperinflation but with the revaluation of Lira in 2005 made this currency the world’s least valued currency.
Depreciation of Currency:
Under the floating exchange rate system a fall in the value of currency relative to another is known as Depreciation of Currency
§ In 1997, Thailand’s “Baht” got depreciated because of its weak financial sectors and decrease in the quality of investment and most importantly the poor banking supervision led many of the foreign investors to pull out of the country.
§ During the period of 2006-2007 the USD depreciated against most currencies, the major reasons behind this depreciation were the narrow interest rate differentials, the subprime crisis and the robust growth in the EURO area.
Appreciation of Currency:
Under the floating exchange rate system an increase in the value of currency relative to another is known as the Appreciation of Currency
In 2008 the USD appreciated against most of the currencies, one of them was Indian Rupees (INR), on 24th October, 2008 INR plunged to a fresh all-time low of 50.11 against the USD, the main reason behind this was the downward trend in the Indian Stock Market which resultantly enforced the foreign institutional investors to sell their Indian stocks by this they would be able to realize their money in USD, the purchase of USD at higher level resulted in the sharp depreciation of INR against the USD.