Question

Expound on a holistic view of exchange rate determination. Address the technical, efficiency and fundamental views of ERs. Give examples of technical and efficiency determination of ERs

Answer 1

ANSWER:

An Exchange Rate is the number of units that can be obtained of the price currency for one unit of the home currency.

• The exchange rate can be fixed or floating. For example, China has a fixed floating rate with the US while India has a floating rate with the US.
• The determination of exchange rates is essential for inter country trades and transfer.
• Any economy will flourish the most if they have open trade strategies because no country has all the resources it desires.
• In order to meet all the needs of the mass and attain maximum productive capacity, foreign trade is important.
• The floating rate of exchange is determined by the market forces of demand and supply.
• When the demand and supply forces meet, the point is the floating exchange rate and the market is called efficient.
• Let’s consider what happens when the demand or supply of a currency changes. For example, if we are considering a EUR/USD exchange rate and USD becomes higher in demand, the value of USD will appreciate and so EUR will depreciate.
• This will result in a higher EUR/USD value because one USD will yield higher units of EUR than earlier.
• However, if the supply of USD increases more than required, there will be a fall in the exchange rate because the units of EUR acquired for one unit of USD will be lower.
• The market remains inefficient till the demand and supply forces collide again.
• While fixed rate of exchange is determined by the Government of the country as per their strategies.
• The government in such cases keeps huge reserves of the foreign currency and adjusts the market demand and supply forces to meet their determined rate of exchange.
• The country that trade more than others generally have an active exchange rate market and are at a better position with higher standards of living.
• The appropriate determination of exchange rates are important because exchange rates help to determine a nation's economic growth and also the welfare and standard of living of all the people residing.