Determination of exchange rates depends on factors causing fluctuations.
An exchange rate is the price of one currency in terms of another. Under inconvertible paper currency system-purchasing power parity and demand supply theory.The former does not exist today so we consider demand and supply theory only. The key factors that determine exchange rates are as follows:
Interest rate-Higher interests rates provides higher rates to lenders and thereby attracting new foreign capital leading to increase in a country's currency.
Inflation - The price of goods and services increase at a slower rate where inflation is low thus with lower inflation rate a country's currency value increases
Current account deficit- A deficit on current accounts of a company due to spending more of its currency on importing products results in currency depreciation.
Government debts- A country with huge government debts could result in lower foreign investment and depreciation in its currency value.
Terms of trade- Terms of trade is the ratio of exports to imports prices.thus when export price rise there is an improvement in terms of trade and results in higher demand of that country's currency.
Political stability and economic performance- A country with more political risks and turmoil can negatively affect the foreign investment in he country . Such a country will not be attractive to the investors when compared to a country with more political and economic stability resulting in more demand to domestic currency.
All these factors results in exchange rate fluctuations.
When the dollars exchange rate rises,it makes it difficult for international businesses to meet their working capital which results in lower trade volumes.It may also strain American businesses dealing with international customers.Thus a rising dollar can result in weakening global growth.On the other hand a weak dollar can result in improving the international business's credit risks and also encourage investments in foreign countries.So if the federal's decision is a lower exchange rate then it is a good news for US businesses and global growth.
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