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Exchange rates

Exchange rates

Author: Matt Cox

Understand how exchange rates are determined in a free floating system.

Analyse how changes in the exchange rate will impact the level of imports and exports.

Evaluate the impact on the economy of a strengthening of the pound.

Analyse what causes the value of a currency to change.

Distinguish between exports and imports.

A look at how the value of a currency can change and how that impacts upon our trade flow and our Aggregate Demand in the economy.  We will study what the results are when a currency changes in value, and how it impacts upon the trading patterns of an economy.  We will also study what causes the exchange rates to change and what the Central Bank can do to alter the value of the currency in the currency exchange market.

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The effect of a currency change

Source: Mr Cox using Smartboard technology

How currency changes value

Source: Mr Cox using Smartboard technology

Powerpoint from class

This is the powerpoint used in the lesson.

Source: Mr Cox using Microsoft Powerpoint

Alternative video to aid the understanding

If you want an alternative explanation, try this video....


Lesson Handout

The Determination of Exchange rates

Millions of pounds worth of currency are traded every day. Anyone can buy or sell currency 24 hours a day. In order to buy goods from other countries people need to first buy that country’s currency. It is that demand for the currency (and supply) that affects the price.

Currency can be demanded for a number of reasons:







In order to supply our currency, we make it available to other countries in exchange for their currency (in other words, undertake the above activities in other countries)

The price of the currency is always determined where supply and demand of the currencies cross.


Fundamentals that drive a currency

Interest rates











Economic Growth

Countries experiencing a deep recession often find that their exchange rate is weakening. Traders in the currency markets may take the slow growth to be a sign of general economic weakness and "mark down" the value of the currency as a result.  On the other hand, economies with strong "export-led" growth may see their currency's rise in value.  Japan is a good example of this in recent years.  The Euro was weak during the first six months of its existence in part because the financial markets were worried about the slow growth of the European economy and the persistently high level of unemployment.









Balance of Payments/Trade

Selling exports represents a demand for the domestic currency from foreign importers. When US consumers buy British Whisky they supply dollars and this is eventually translated into a demand for pounds.  Similarly when UK consumers buy imports, they supply their own currency and this is eventually translated into a demand for foreign currencies.  If a country is running a substantial trade surplus there is a large demand for the currency and its value should appreciate. By contrast a massive trade deficit usually causes the currency to lose value.

Market Speculators









It is difficult for governments to offset the power of speculators because their reserves of foreign currencies are very small compared to daily turnover in the market. We saw in 1997 and 1998 speculative attacks on currencies in Asia and in 1993 the pound was forced out of the European exchange rate mechanism because of speculative selling of the pound.


Measuring the Exchange rate





Source: Mr Cox