EXCHANGE RATE FLUCTUATIONS- TRADE AND INTEGRATION

EXCHANGE RATE FLUCTUATIONS

Bilateral exchange rate: the exchange of one currency against another

Effective exchange rate: the exchange rate of one currency against a basket of currencies of countries, often weighted according to the amount of trade done with each country 

•  Bilateral exchange rates show greater fluctuations than measures of effective exchange reates                                  CAUSES OF EXCHANGE RATE FLUCTUATIONS
• exchange rate fluctuations are brought about by changes in the demand and supply of that currency 
•  long term changes in the demand and supply: is caused by changes in the value of exports, imports and long term capital transactions 
• These 3 factors are influenced by the 5 economic fundamentals:
• 1- rate of inflation 
• 2- interest rate 
• 3- rate of economic growth 
• 4- labour productivity
• 5- measures of international competitiveness generally 
• These 5 fundamentals show that the ER gradually moves towards its equillibrium which is PPP( the exchange rate that equalises the basket of identically traded goods and services within a country. It is an attempt to measure the value of a currency in terms of the amount of goods and services it will buy)
• Short term changes in the demand and supply of a currency is caused by speculation 
• speculators react…