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Determination of Exchange Rate - Coursework Example

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Determination of Exchange Rate Tutor: Date: History of Exchange Rates As noted by Bagella et al (2006, p.1151), the choice of policies of exchange rates was not so vexing sometimes back. In modern period, the selection of an exchange rate policy that suits a country is vital since though the selection of the policy is convenience based given application of international rules and regulations…
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Determination of Exchange Rate
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Determination of Exchange Rate

The initial period was 1870 to 1914 where most countries adopted the gold standard where gold was used as domestic money. The above gold standard was a uniform exchange rate regime, though some countries constantly used silver while other countries gold inconvertible currencies (Ehrmann and Fratscher, 2004, p. 105). The start of the First World War interrupted this exchange rate era thereby bringing in the second phase that was 1914-1946. Under this second period, there were many changes as many countries saw great variations of currencies used among countries and the over time. Exchange controls were initiated with most countries utilizing the floating exchange rates (Escobar, 2012). It was noted that in the late 1920s, the efforts to restore the gold standards as were before the war began aborted (Deaton and Duprietz, 2011, p. 152). The exchange rate policy was dominated by the Breton Woods agreement that was signed in 1944 between 1946 and 1973. Through this pact, countries agreed to commit themselves to convertible currencies that could be converted to the current account and the fixed exchange rate (Chinn and Hiro, 2005, p. 301). The pact enhanced eschew of exchange controls and fixing the exchange rates due to the negative lessons that were experienced after the world war (Bagella, et al. 2006, p. 1152). Despite the increased application and use of the Breton Woods pact, Kenen (2000, p. 111) posits that the arrangement was strained since the 1960s and in 1973, fixation of exchange rates was officially abandoned by most countries in Europe and Japan thereby ushering in the next period of exchange rates that has been in application since 1973 to date where countries use floating exchange rates (Chinn & Hiro, 2005, p. 303). 2.2 Types of Exchange Rates 2.2.1 The Nominal Exchange Rate Regime The nominal exchange rate is the exchange rate of a given currency whose value is not averagely weighted in relation to the major currencies across the globe (Cooper, n.d.: 21). The weights of the currency are determined by the domestic country that places its currency in a given pool of global currencies that are measured by the balance of trade between these countries. The nominal effective exchange rate (NEER) is the relative value of a domestic currency as compared to major global currencies such as the U.S. Dollars, the UK Pound and the Japanese Yen among others. A high NEER implies that the domestic currency has a more value than the foreign currency while a lower NEER implies that the domestic currency has a less value as compared to the foreign currency. As noted by Eichengreen and Leblang (2003, p. 804), the nominal exchange rate refers to the exchange rate of a given currency in relation to the given foreign currency. 2.3 Real Exchange Rates Galindo (2006, p. 64) note that the real exchange rate can be distinguished from the nominal exchange rates since real exchange rates refers to the cost of foreign good relative to the cost of domestic products. It provides the required competitiveness in the market and it is necessary in explaining the behavior of trade and national income in a competitive global economy. The real exchange rate is usually volatile and it keeps varying based on various business environment factors (Ickes, 2004, p. 16). The big fluctuations in the real exchange rates could lead to improved welfare to an economy, though this is not ... Read More
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