Macroeconomic Variables & Exchange Rate-Free-Samples for Students

Question: Discuss about the Macroeconomic Variables Exchange Rate. Answer: Introduction: The building block of world economy is the globalization that has helps the nations to be connected thoroughly through share and exchange of goods and services. These goods and services can range from anything from consumer goods, business outsourcing service, industrial input as well as final goods or even intangible services including technology, research and development components and so on. In the modern world full of international trade and business taking place among nations, exchange rate plays pivotal role in the transactions. Exchange rate is generally the price derived from currency corresponding to one nation in terms of the currency operating in another nation. It depicts the value of one currency in exchange of the other currency. It helps in determining prices of goods and services exported from a country and determine the price to be paid for import made by the country. Prices vary as per value of internationally standardized exchange rate is changing in terms of revaluation or devaluation of national exchange rate. This paper is prepared to discuss one selected article that analyses the important influence of macroeconomic variables like rate of interest on the exchange rate. The article includes study of exchange rate fluctuation is done with the help of theoretical as well as applicatory evidences (Ramasamy, Ravindran, and Abar 2015). The aim of this paper is to bring out the underlying economic theory applied in the chosen article and pose a discussion thoroughly keeping parity with the idea synthesized in the article. Discussion: Evidence Method Of Research: The article analyzes the impact various macroeconomic variables of a nation has on its exchange rate. In any economy when viewed through macro lens, various important variables are found to influence the overall economic performance of it. Exchange rate is one of the important economic indicator that strongly get influenced by the variables operative in macro economy such as rate of interest, rate of inflation, balance of payments, tax rates and so on. These factors are unstable and connected to the different nature that economies of different nations have. These further make the exchange rate volatile, which comes with deeper impacts evident in the condition of trade, business and investment decisions made. With making an introduction of the exchange rate and its importance, the paper goes on showing the relationship of it with other macroeconomic variables with the help of regression analysis. To analyze the roles of macroeconomic variables on exchange rate and its fluctuation annual exchange rate data of three countries has been collected. Generally the data regarding AUD/USD, Euro/USD, AUD/Euro are arranged. Germany , United States and Australia are strong global economies operating with less unemployment and budget deficit. Ten years time series data are incorporated that brings forth 30 samples (Ramasamy, Ravindran, and Abar 2015). Using bootstrapping method the sample size has been increased and the regression has been run to assess the impact. Multi models are applied with following proper link with the complementary variables in order to find out the best model. The model B that briefs down that excluding employment and deficit budget, almost all of the macroeconomic variable influences exchange rate significantly. Majority of the macroeconomic variable found to be affecting the exchange rate with a sign opposite to the expectations formed in favor of them. The conc lusion has been made that psychological factors such as confidence of the investors exerts dominance upon the economic variables in order to decide the fluctuation in exchange rate. Macroeconomic Theory : Exchnage Rate: Exchange rate of a country is the depiction of the valuation of the national currency in terms of other international currency while exchanging goods and services in any transaction. It refers to the unit of domestic currency needed to acquire one unit of foreign currency. So it can refer to the price of foreign currency paid in terms of domestic currency. For example, Dollar-Euro exchange rate is given by, 1 USD= 0.85 Euro which implies to buy 1 unit of US dollar, 0.85 Euro is required. Exchange rates are of following types: Nominal Exchange Rate: In general terms, the exchange rate of any currency in terms of other is called the nominal exchange rate. The term nominal refers to money value hence it is a bilateral concept. Real Exchange Rate: It refers to the rate at which domestic goods are exchanged foreign goods and services than actual rate at which exchange of currencies take place. RER refers to the amount of domestic goods to be given up in order to derive one unit of foreign goods. Effective Exchange Rate: It is measured as weighted average of nominal exchange rate (NER). The weights are considered as share of the other countries involved in trade with the nation in question. Suppose US trades with (70 percent of share) and India (30 percent) only. The NER of the USD are 0.58 INR and 0.0089 Japanese Yen. Then EER= 0.7(0.0089) + 0.3(0.58) = 0.180 This implies for $0.180, one can buy basket containing 0.7 yen and 0.3 INR. Spot Exchange Rate: The spot exchange rate refers to the rate applicable for any transaction taking place on immediate basis Forward Exchange Rate: The forward exchange rate refers to an agreement made upon on the exchange rates of two currencies that is to be applicable in future date as agreed. The exchange rate of a nation is determined by the supply and demand of foreign currency in the foreign exchange market of any specific country. Demand for foreign currency stems form import of good sand services and denotes a capital outflow. The supply of the same is indication of capital inflow as it helps earning that through export. Based on the interventions and operations of the market the nations decides upon the regime its exchange rate is going to have. Exchange rates can be fixed or free floating or mixed of both the system. Flexible exchange rate system: The supply and demand curve of foreign currency are plotted against the exchange rate e. Rise in e implies depreciation of home currency as more of it has to be forgone to buy one unit of foreign currency. This situation discourages import and encourages export. As a result demand for the foreign currency would be lower whereas supply of it will be higher with respect to rise in e and this further explains the slope of the demand and supply curves Here the exchange rate is determined by the market force excluding the intervention made by central bank hence the exchange rate is known as flexible exchange rate. Now suppose due to any exogenous reason the supply of foreign currency increases due to say increase in the demand of domestic currency by the foreign counterparts, then supply curve would shift rightward and make the exchange rate fall. This is called appreciation exchange rate that makes foreign currency less costlier now in terms of home currency Fixed exchange rate system: Here the exchange rate is not determined by the free force of foreign exchange market but by the influence and discretion of central bank of nation. The bank can decide upon what is going to be the exchange rate and fixed the value accordingly and makes upward revision called devaluation of home currency or revaluation of foreign currency and if makes downward revision of that then revaluation of home currency equivalent to devaluation of foreign currency happens. According as the exchange rate the demand and supply of foreign exchange are manipulated and maintained. To meet the excess demand or supply of foreign exchange, the national bank resorts to depletion or addition to its foreign exchange reserves. Importance of exchange rate in an economy: In determining the prices of transaction and in indentifying the mode of hedging to avoid risk associated with it, in determining the quantum of foreign trade and its direction, exchange rate plays crucial role. Various macroeconomic variables of home and foreign country exerts influence on equilibrium of the exchange rate and its fluctuation. Fluctuations in short run are subject to temporary economic upheaval. The income and capital inflows and outflows in terms of foreign direct investments impact the state of exchange rate that further impacts the investment and business decisions made by other countries with any specific nation. The fluctuation of exchange rate determines the balance of trade and foreign reserve of the country too Macroeconomic Variables Influencing Exchange Rate: Interest Rate: It refers to the amount to be paid as interest as proportion to the amount lent or borrowed by individual and the rate is charged by banks. The prevailing interest rate of both the home and foreign country plays important role in determining exchange rates. The lending rate is increased by central bank amidst inflationary pressure in order to make borrowing expensive and makes reduction money supply. If changes in home interest rate is not matched by change in foreign interest rate, then demand and supply equilibrium of money gets disrupted causing fluctuation exchange rate. This can bring forth profitable borrowing and investing between countries if not arbitrage take place. But same might not be derived if the foreign nation revises its interest as the home. Inflation Rate: The inflation rate refers to the increase in general price level prevailing in any nation. It is measured by Consumer Price Index. Inflation is equivalent to depreciation of home currency that reduces its value and makes he foreign currency valuable and dearer as well. The exchange rate and inflation rate is found to be negatively correlated. Balance of Payment: The balance of payments (BOP) is a net indicator of capital flows of foreign currencies. The balance of payment indicates the net capital flow of a country. It is consisted of current account and capital account. The transaction of goods and services, interest payments and unilateral transfers are recorded in current account records. The inflows add as credit and outflows deducts as debit and the net of balance the result in deficit or surplus in current account in a given year. The capital account records the inflows and outflows. of FDIs and the portfolio. Both of these accounts determine the quantum of foreign exchange reserve that further impacts the exchange rate. Budget Deficit: When the expenditure of the country is more than the income or revenue earned, then the country is said to be running under budget deficit. To finance the deficit government can resort to borrowing fro other nations that leads to interest payment. The exchange rate determines the cost of borrowing. The borrowing or lending influences the balance of payment that impacts the foreign exchange in turn. There is no direct impact found of the deficit budget on the exchange rat even though the reverse is quite applicable. Regression Analysis: The tool of the analysis applied in the article has been regression analysis. In the econometric theory, regression analysis refers to finding out the impact of one or more variable known as independent variable on the dependent variable in presence of some ssumptions. In the paper the regression equation has been termed as: = + + + + , = 1, , . where y = Exchange rate a = Intercept = coefficient of regression that is to be estimated x = Independent variable i = List of independent variables x1= interest rates (Relative) x2= inflation rate (Relative) x3= balance of payments (Relative) x4= employment rate (Relative) x5= corruption index (Relative) x6= gross domestic product (Relative) x7= deficit/surplus rate (Relative) x8= tax rate (Relative) x9= borrowing (Relative) In terms of all of these macroeconomic variable theimpact of them on the rate of exchange is determined (Ramasamy, Ravindran, and Abar 2015). Conclusion: The investigation of the three economically sound economies exchange rate has led to revelation of important facts and discussions regarding the relationship of various macroeconomic variables that a country have with the exchange rate. The results of the empirical study show interesting result. Balance of payment, inflation rate and interest rate found to have negative relation with exchange rate as opposed to the theory that induces positive result. The reason behind such is the strength of currency backed by public and investors confidence. The independent variables have complex interrelationships that is failed to be captured by the traditional regression analysis. The discussion presented in paper enlighten us about the economic theory underlying the exchange rate system of a nation that plays important role in economic performance through trade, investment and final impact on GDP. The revelation help the layman know about what should be the macroeconomic policies manipulating t he variables to deal with exchange rate risks and problems in order to make the economy more healthy and stable References Akbar, Muhammad, Shahid Ali Khan, and Faisal Khan. "The relationship of stock prices and macroeconomic variables revisited: Evidence from Karachi stock exchange." (2012). 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