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S t - St-1
St
x100%
Where:
St spot rate at more recent period
St-1 spot rate at earlier period
(+) change indicates appreciation
(-) change indicates depreciation
(2)
(4)
Government Control
The government of foreign countries can influence
equilibrium exchange rates in many ways:
1. Imposing foreign exchange barriers
2. Imposing foreign trade barriers
3. Affecting macrovariables such as inflation
rates, interest rates, and income levels
Recall the instance on increase in US interest rates.
British supply for pounds increased right? Yet, if the
British government placed a heavy tax on interest
income earned from foreign investments, this could
discourage the exchange of pounds for dollars
(5)
Interaction of factors
Think about this:
Assume the simultaneous existence of (1) a
sudden increase in U.S. inflation and (2) a sudden
increase in U.S. interest rates. If the British
economy is relatively unchanged, the increase in
U.S. inflation will place upward pressure on the
pounds value because of its impact on
international trade. Yet, the increase in U.S.
interest rates places downward pressure on the
pounds value because of its impact on capital
flows.
The sensitivity of an exchange rate to these
factors is dependent on the volume of international
transactions between the two countries. If the two
countries engage in a large volume of international
trade but a very small volume of international
capital flows, the relative inflation rates will likely
be more influential. If the two countries engage in
a large volume of capital flows, however, interest
rate fluctuations may be more influential.
(3)
% change / movement
x100%= -
14.3%
Anticipation of Exchange Rate Movements
(1) Institutional Speculation Based on Expected Appreciation
Example A
(2)
Example B