BUS 1104 – Macroeconomics

University of the People

Exchange Rate

Instructor – Anju Mehta

Exchange Rate

The foreign exchange market, sometimes known as the currency, or currency market, determines

the global currency exchange rate. It is extremely important in every economy since it permits

the exchange of exports and imports, which has an impact on aggregate demand, real GDP, and

price levels. The currency market is significant in the economy because it has an impact on

general demand, real GDP, and price levels through influencing changes in exports and imports.

The price of a country's currency against another at a certain point in time is known as the

exchange rate. People purchase a country's currency for a variety of reasons, including the

purchase of products and services in that country, as well as the acquisition of its assets, such as

money, coins, securities, shares, or real estate (Rittenberg et al., 2012).

The interest rate is one of the most important elements influencing the exchange rate. The value

of a country's currency will rise if interest rates are raised. In the foreign exchange market,

interest rates have an impact on the value of a currency. Because the US has higher interest rates

than the UK, the dollar will grow in value against the pound. As a result, American exports will

become less competitive, resulting in reduced exports and higher imports. This reduces aggregate

demand in the economy. When a currency's demand rises, it acquires strength or rises in value

against other currencies. Buying assets that are denominated in dollars necessitates the purchase

of dollars. As a result, the value of its currency improves or rises. As a result of this predicament,

foreign investors will either sell their UK assets or move their capital to the United States,

where their foreign currencies will be converted to dollars.

Because the rising currency rate makes US products and services less enticing to foreigners, net

exports will be reduced as interest rates rise. High interest rates will also lower US expenditure

and net exports, causing the aggregate demand curve to move to the left. A decline in net exports
lowers overall demand, whereas an increase in worldwide rates relative to US rates has the

reverse effect. Investors would most likely save in American banks if interest rates were raised.

However, the dollar's high exchange rates will show in its exports. This is because if the UK

needs to buy US goods, it will have to pay more in UK pounds. Furthermore, the value of gains

on export sales drops when foreign profits, in this case, pounds, are changed back to dollars. The

low exchange rate of the dollar can have a negative effect on local American enterprises. This is

because a strong currency equals cheaper imported goods, while domestic ones are more

expensive. As a result of this situation, imports may outnumber exports, resulting in a potential

trade deficit.

Variations in the exchange rate can also affect tourism. Because the US dollar is higher than the

pound, a trip to London is less expensive for an American. If the US dollar strengthens against

the British pound, for example, American travelers visiting London will find that products and

services are cheaper. As a result, the amount of goods and services sought by American tourists

in the UK will rise, increasing demand and shifting the demand curve to the right.

In conclusion, a government's actions have an impact on interest rates, which in turn have an

impact on a country's currency value. In comparison to other economies, higher interest rates

give borrowers with higher yields. Higher interest rates encourage international investment,

which causes the exchange rate to rise. When this happens, the global price of goods and services

rises due to increasing interest rates and exchange rates. As a result, taking a vacation to London

when interest rates rise will be less expensive for an American tourist since they will be able to

consume more goods and services in the UK for the same amount of money.
Reference

United States - Trade - European Commission. (n.d.). Retrieved December 6, 2021, from

https://ec.europa.eu/trade/policy/countries-and-regions/countries/united-states/

Rittenberg, L. and Tregarthen, T. (2012). Macroeconomics Principles V. 2.0. Licensed under

Creative Commons by-nc-sa 3.0 https://creativecommons.org/licenses/by-nc-sa/3.0/