Question

Foundations of Financial Management: Factors that influence exchange rates

Answer 1

Four Major factors that affect the exchange rate are
1. Inflation: Inflation in the long run occurs due to supply side constraints. If long run demand is higher than supply inflation occurs,. Long run inflation cannot be minimised by monetary policy which are short term . In fact fiscal policy or government policies can reduce long term inflation

Higher the inflation lower the exchange rate of domestic currency in the long run.

2. Economic growth or GDP(Gross Domestic Product) : Increase in real income of country strengthens the economy in teh long run and impacts exchange rate.
Higher the GDP higher is the exchange rate of domestic currency .

3. Relative Productivity of a country : The productivity is the efficiency in generating goods and services of a country. This makes the goods and services of generated in a country to be very competitive as compared to foreign goods and services

Higher the productivity higher will be the exchange rate in the long run.

4. Trade  Barriers: Trade barriers means increasing  the tax of imported goods or putting restriction in  their quantity .

Higher the trade barrier higher is the exchange rate of domestic currency.