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

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. Lets 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.