8/10/2019 10. Exchange Rate Policy

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GN.AEC,Gr.11Economics Page1

Unit

2

10.

The

Rate

of

Exchange

policy

The rateof exchange is the rate atwhich one countrys currency is

exchanged for another countrys currency. It is the price of one

currencyintermsofanother.Forexample,iftherateofexchangeis1

=$2,thenthepriceofapoundis$2andthepriceofadollarishalfa

poundor

50

pence.

Countries

may

operate

floating,

fixed

or

managed

exchangeratesystem.

Exchangeratesystems

1.

Flexible

or

floating

exchange

rate

system

A floatingexchange rate system isonewhere the ratesofexchange

between thedomesticand foreigncurrenciesaredeterminedby the

forces of demand and supply without any official (government)

intervention. It is also known as freely (clean) floating or freely

fluctuatingexchange rate.Under thisexchange ratesystem, the rate

atwhichonecurrencyexchangesforanotherdependsonthedemand

for and supply of that currency in the Foreign Exchange Market

(FOREX).

Demand

for

pounds

()

in

the

FOREX

Pound is demanded by overseas residents (households, firms and

governments)intheforeignexchangemarketwhen

theywanttobuygoodsandservicesfromtheUK,or

they wish to make investment in Britain (to buy land and

property in theUK,buy shares inBritishcompanies,ormake

loanstoBritishresidents,todepositmoneyinUKbanks).

Forthesepurposes,overseasresidentswillneedpounds,andtheywill

buy these pounds by offering their own currencies in exchange for

them.

Thesupplyofpounds()intheforeignexchangemarket

PoundissuppliedtotheforeignexchangemarketbyBritishresidents

when

theywishtobuygoodsandservicesfromothercountries,or

theywishtomake investment inothercountries (buying land

andproperties

in

other

countries,

buying

shares

in

foreign

companies,making loanstooverseasresidentsanddepositing

moneyinoverseasbanks)

For thesepurposes,UK residentswillneed foreigncurrencies,which

theywillbuybyofferingpoundsinexchangeforthem.

TherateofexchangeofpoundintheFOREXisdeterminedwherethe

demand for pound is equal to the supply of pound. The rate of

exchangeof

pound

is

expressed

in

terms

foreign

currencies.

This

is

showninfigure1.

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GN.AEC,Gr.11Economics Page9

UKsConditionsThe labourgovernmenthas setout fiveconditionswhichhave tobe

metbeforetheUKwillconsidermembership.Theseareasfollows.

Membershipmustbeexpectedtocreatebetterconditionsfor

companiestoinvestintheUK

TheeffectontheUKsfinancialservicesindustrywouldhaveto

bebeneficial

TheremustbeaconvergenceofEuropeanbusinesscyclesand

economicstructures

Theremust

be

sufficient

flexibility

for

the

system

to

cope

with

economicchangeandshocks

Membershipmustbegoodforjobsandeconomicgrowth