What might cause an appreciation of a floating exchange rate? Essay

What might cause an appreciation of a floating exchange rate? Discuss whether an appreciation of a country's exchange rate will always be beneficial to that country. a) what might cause an appreciation of a floating exchange rate? b) Discuss whether an appreciation of a country's exchange rate will always be beneficial to that country. (15) A free, fluctuating or floating exchange rate means the existence of a free or competitive foreign exchange market where the price of one currency in terms of another is determined by the forces of supply and demand operating without any official interference. ====================================================================== A rise in the price of a currency in terms of another currency is called an appreciation. ================================================================= The following figure shows the equilibrium price of pounds in terms of U.S dollars. Short and long-term movements in the exchange rate, like any price, are caused by changes in market demand and supply conditions. The appreciation of a country's currency will occur due to either an increase in demand or fall in supply of that currency. The demand for sterling (pounds) in the FOREX markets comes from many sources UK goods and services are exported overseas - . if there is an increase in exports this will create an inflow of currency into to the UK which needs to be turned into sterling this will increase demand for the sterling . When US consumers but British Whisky they supply dollars and this is eventually translated into a demand for pounds. This will cause an outward shift in the demand curve for sterling, thus causing the currency to appreciate. Foreign long te... ...viously cause a serious fall in living standards. Exchange rate and inflation: An appreciation of the exchange rate helps to control cost and price inflation in the economy. A fall in import prices means that it is cheaper to import raw materials, components, finished manufactured products leading to an outward shift in Short Run Aggregate Supply shown in diagram - this has a direct impact on the Retail Price Index Tougher for domestic companies to compete with cheaper imports - lower profit margins as businesses have to adjust (less pricing power in their markets) Slower growth of exports (leading to a slowdown in aggregate demand - possibly the emergence of a negative output gap where actual GDP A bigger trade deficit represents a net outflow of demand from the circular flow of income and spending - leading to less demand-pull inflation.