1

Recall that an exchange rate is the price of one currency in another. For example, it may take US $1.35 to
buy 1 British Pound. Also recall the interest rates affect exchange rates. What do you predict will happen
to the foreign exchange rate if interest rates in the United States increase more than in the UK? (In other
words, which currency will become stronger?) How would such a change affect US exports to the UK?
Would it be less expensive for an American tourist to take a vacation to London after the interest rate
change? Be sure to clearly explain and justify your reasoning.

A currency exchange rate is the price of one currency in respect to another. The demand for

a country's currency determines exchange rates, which are decided in the foreign exchange

market. Every currency has an exchange rate against every other currency. The exchange rate for

the US dollar in British pounds is expressed as pounds/USD, indicating how many British

pounds are to be paid for one US dollar. When a country experiences rapid growth, the value of

its currency rises.

This is due to the fact that international players being more interested in investing in the

country must result in the country's financial balance being positive. When the capital inflow

exceeds the capital outflow, the demand for the country's currency rises, and the currency

becomes stronger.

With regards to the question of what might happen to the foreign exchange rate:

Changes in interest rates have an impact on the currency's value and its connection to the US

dollar, the British pound, and other currencies. High interest rates boost the value of the

currency. In this scenario, the US dollar will become stronger than the British pound due to the

fact that the US interest rate has been raised higher than the UK interest rate, implying that more

pounds will be required to acquire one dollar. When interest rates rise, net exports fall;

consequently, an increase in the exchange rate makes US products and services less appealing to

foreigners; as a result, net exports fall.

 2

Interest rates, inflation, and exchange rates are all closely connected with one

another. Central banks influence both inflation and exchange prices through intervening and

adjusting interest rates. Interest rate changes have an impact on inflation and currency values.

Larger interest rates provide a higher return to lenders in an economy when compared to other

countries. As a result, higher interest rates attract foreign money, causing the currency's

exchange rate to rise. However, the effect of increased interest rates is offset if inflation in the

nation is significantly greater than in other countries, or if other circumstances contribute to

depreciate the currency. Lowering interest rates has the reverse effect; lower interest rates tend to

reduce exchange rates.

The current account is the sum of a country's exports and imports of commodities

and services. The exchange rate is affected by changes in the current account balance rather than

the current account balance itself. Exports may fall in the future, causing the currency to weaken,

and vice versa. In this example, a stronger US currency makes imports cheaper and exports more

costly in overseas markets. In international markets, a lower-valued currency makes imports

more expensive and exports less expensive. A higher exchange rate is consequently predicted to

worsen a country's trade balance, whilst a lower exchange rate is expected to improve it.

Determining the optimal value for a currency is therefore difficult, but it is something that central

bank governors and economists all around the world consider on a regular basis. Exchange rates

are determined by a variety of variables. Many of these variables are connected to the

commercial connection between two nations such as the United States and the United Kingdom.

Keep in mind that exchange rates are relative and are provided as a comparison of two nations'

currencies (Rittenberg and Tregarthen 2012).

 3

Considering what might happen to the price of the London vacation: I believe that

the fact that the US exchange rate is greater than the UK exchange rate suggests that an

American tourist in London would find it cheaper since the US dollar is higher than the UK

pounds. Because goods and services would be cheaper in London for American tourists, the

quantity required of products and services in London would grow. The currency rate is

influenced by a country's overseas commerce, economic development (GDP), and central bank

actions. When a country experiences rapid growth, the value of its currency frequently rises. This

is due to the fact that international players being more interested in investing in the country must

result in the country's financial balance being positive. When the capital inflow exceeds the

capital outflow, the demand for the country's currency rises, and the currency becomes stronger.

Knowledge, like anything else, is generally rewarded in the foreign currency market.

Knowing what causes currency rates to rise or fall is essential information. Aside from interest

rates and inflation, the exchange rate is one of the most significant indicators of a country's

economic health. Your foreign exchange trading is also influenced by the balance of payments

for various nations, the central government debt, the trade balance, and a variety of other

variables. Exchange rates have a significant impact on a country's trade level, which is critical

for the majority of the world's free market economy. As a result, exchange rates are among the

most closely monitored, studied, and state-manipulated economic indicators. On a lesser scale,

exchange rates also play an impact. Every second, live exchange rates impact an investor's

portfolio's real return.

(Words 950)

References
 4

Rittenberg, L. and Tregarthen, T. (2012). Macroeconomics Principles V. 2.0. Licensed under

Creative Commons by-nc-sa 3.0 (https://creativecommons.org/licenses/by-nc-sa/3.0/).