EXCHANGE RATE EQUILIBRIUM
EXCHANGE RATE APPRECIATION
An increase in demand for pounds means that more people want to buy pounds, which increases the demand for pounds in the foreign exchange market. This increased demand leads to a shift in the demand curve for pounds to the right.
As the exchange rate for pounds increases, the quantity of pounds supplied also increases, as suppliers are willing to offer more pounds at higher exchange rates. The movement along the supply curve for pounds shows an appreciation of the pound against the dollar. This means that the pound is now worth more relative to the dollar than it was before.
FOR EXAMPLE…
If foreign investors increase their demand for Japanese stocks or bonds, they would need to buy Japanese Yen to make these investments. As a result, the demand for Japanese Yen would increase, causing its value to appreciate against other currencies. This, in turn, makes Japanese exports more expensive and potentially reduces their demand, leading to a possible decrease in the country’s economic growth.
A decrease in supply of pounds in the foreign exchange market leads to a leftward shift of the supply curve for pounds, indicating that suppliers are willing to offer fewer pounds at every exchange rate.
As a result, the exchange rate for pounds increases relative to the dollar. This appreciation of the pound against the dollar is shown by a movement along the demand curve for pounds, which represents the quantity of pounds demanded at every exchange rate. As the exchange rate for pounds increases, the quantity of pounds demanded decreases, as buyers are less willing to buy pounds at higher exchange rates.
FOR EXAMPLE…
In 2015, The Chinese government implemented capital controls to limit the outflow of capital from the country, reducing the supply of Yuan in the foreign exchange market. This, in turn, caused the value of the Yuan to appreciate against other major currencies. The decrease in the supply of Yuan was due to the government’s efforts to stabilize the country’s financial markets and prevent a large-scale capital flight.
EXCHANGE RATE DEPRECIATION
A decrease in demand for pounds means that less people want to buy pounds, which decreases the demand for pounds in the foreign exchange market. This decreased demand leads to a shift in the demand curve for pounds to the left.
As the exchange rate for pounds decreases, the quantity of pounds supplied also decreases, as suppliers are less willing to offer pounds at lower exchange rates. The movement along the supply curve for pounds shows a depreciation of the pound against the dollar. This means that the pound is now worth less relative to the dollar than it was before.
FOR EXAMPLE…
In 2020, when the COVID-19 pandemic hit, foreign investors pulled out their investments from India due to the uncertainty surrounding the pandemic. This led to a decrease in demand for the Indian Rupee, causing its value to depreciate against other major currencies. This, in turn, made imports more expensive and potentially fueled inflation in the country.
An increase in supply of pounds in the foreign exchange market leads to a rightward shift of the supply curve for pounds, indicating that suppliers are willing to offer more pounds at every exchange rate.
As a result, the exchange rate for pounds decreases relative to the dollar. This depreciation of the pound against the dollar is shown by a movement along the demand curve for pounds, which represents the quantity of pounds demanded at every exchange rate. As the exchange rate for pounds decreases, the quantity of pounds demanded increases, as buyers are more willing to buy pounds at lower exchange rates.
FOR EXAMPLE…
The Venezuelan Bolivar has experienced hyperinflation due to excessive money printing by the government. As a result, the supply of Bolivars has increased rapidly, causing its value to depreciate against major currencies. This, in turn, has led to economic turmoil in the country, with high inflation rates and a decrease in purchasing power for its citizens.