Presentation: Appreciation of currency
- января 24, 2017
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This article and the presentation, which you can find at the end of the article, are the results of the home assignment of three students for the Global Business class at EF New York 2016-2017.
What is an appreciation of an exchange rate?
A rise in the exchange rate is known as an appreciation in the exchange rate (or revaluation (the opposite of “devaluation”) in a fixed exchange rate system). It means the value of one currency increased in terms of another.S2 = S1 * C1/C2,
where Si -- the value of a commodity in i-th currency; C1/C2 -- exchange rate C1 to C2.
Why does the exchange rate change?
Exchange rates are determined by basic supply and demand factors. The demand for a currency is influenced by factors, such as interest rates, economic growth, inflation, government policy and business cycles. The demand for a currency on the international exchange markets depends upon the demand for that country's products in the international markets. For example, if there was greater demand for American goods then there would tend to be an appreciation (increase in value) of the dollar. Factors that make us want more foreign goods, services, and assets more attractive (eg. more income, lower foreign prices, greater perceived value of foreign goods, higher foreign interest rates, etc.) will increase the demand for the foreign currency and cause it to appreciate. Factors that make foreign goods, services, and assets less attractive to us will lower the demand for the foreign currency and cause it to depreciate.
For example, suppose that Americans decide to go on an international spending spree and stock up on British tea sets. What will happen? The new demand for tea sets will increase demand for the British pounds needed to buy them. This shifts the demand for pounds from D0 to D1 and, at the original exchange rate (ER0) creates an excess demand for pounds. How do we induce the British to part with their pounds? We offer them a better deal. The new demand drives up the equilibrium rate to ER1. With the dollar price of the pound rising, the British pound has appreciated and the dollar has depreciated.
A value of a currency.
Currencies are quoted and traded in pairs. Unlike a stock, of which the price represents its value, a currency quote is a rate at which one currency is exchanged for another.
What happens to the currency when interest rates rise?
The higher interest rates that can be earned tend to attract foreign investment, increasing the demand for and value of the home country's currency. Conversely, lower interest rates tend to be unattractive for foreign investment and decrease the currency's relative value.
Consequences of a currency appreciation.
The cost of goods and services increases in value for international tourists and people, who use other types of currency.
Consequences (national) of a big currency appreciation.
For a currency, too much appreciation can have a negative impact on the underlying economy. For example, for a country with an appreciating currency, imports become cheaper, which translates to a benefit of lower prices, leading to lower overall inflation. However, that same currency appreciation makes exports more expensive to foreign buyers and ultimately curtails demand for the country’s products. This eventually leads to a reduction in gross domestic product (GDP), which is definitely not a benefit. Currency rates are, therefore, subject to the ebb and flow, or appreciation and depreciation, that correspond with the economic and business cycles of the underlying economies and are driven by market forces.
Example -- Russia
At present, Russia employs a floating exchange rate regime, which means that the ruble exchange rate against foreign currencies is set by the market, i.e. the ratio between the demand for foreign currency and its supply in the FX market. Any factors disturbing this ratio initiate exchange rate fluctuations. In particular, exchange rate dynamics may be influenced by changes in export and import prices, inflation levels and interest rates in Russia and other states, economic growth rates, investors’ sentiment and expectations in Russia and worldwide, changes in monetary policies pursued by central banks in Russia and other countries.
Thus, the ruble exchange rate is not set by the government or the central bank, it is not fixed, but there are targets set for its level and rates of change. It’s a common action that the Bank of Russia conducts interventions to influence the rubble dynamics.
The Bank of Russia switched to the floating exchange rate regime in November 2014. Prior to this transition, for many years the Bank of Russia had gradually increased exchange rate flexibility and had consistently reduced its interference in the domestic FX market. The transition to the floating exchange rate regime was a phase-out process in order to facilitate market participants’ adaptation to exchange rate fluctuations driven by the more flexible exchange rate.
Presentation link: google slides
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