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Rashedul Hasan
Value of
$1.60
$1.55
$1.50
S: Supply of
equilibrium
exchange rate
D: Demand for
Quantity of
where,
e = % change in spot rate
INF = change in the differential between U.S.
inflation and the foreign countrys inflation
INT = change in the differential between U.S.
interest rate and the foreign countrys interest rate
INC = change in the differential between
U.S.income level and the foreign countrys
income level
GC = change in Government control
EXP = change in expectations of future
exchange rate
S1
S0
D1
D0
Quantity of
U.S. inflation
S0
S1
D0
D1
Quantity of
$/
S0 ,S1
r1
r0
D1
D0
Quantity of
Government Controls
Governments may influence the equilibrium
exchange rate by:
imposing foreign exchange barriers,
imposing foreign trade barriers,
intervening in the foreign exchange market,
and
affecting macro variables such as inflation,
interest rates, and income levels.
Expectations
A fifth factor affecting exchange rate is market
expectations of future exchange rate. Like other
financial market,
Foreign exchange markets react to any news that
may have a future effect.
Institutional investors such as, Commercial Bank,
Insurance Company etc. often take currency
positions based on anticipated interest rate
movements in various countries.
Exchange
rate
between
foreign
currency
and the
dollar