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8/10/2019 10. Exchange Rate Policy
1/9
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