Exchange

rates
 Explain downward and
Define ‘fixed exchange
upward adjustments to
rates’
value of currency

Learning
objectives: Explain an ‘appreciation’
Define ‘floating
and a ‘depreciation’ of
exchange rates’
currency
 Definition:

• The exchange rate is the rate at which one

currency can be exchanged for another
country’s currency in the foreign exchange
market.
 Foreign exchange market

• The foreign exchange market is a market that

specializes in the sale of different currencies.
The exchange rate can also be expressed as the
price of a US dollar in terms of TT dollars.
• US$1 = TT$6.33
• The Belize Dollar (BZD) is the official currency of Belize, first issued in 1974.
The BZD is pegged (fixed) to the U.S. dollar at a rate of 1:2. Prior its
independence, Belize used the British Honduras dollar, British pounds, and
Spanish dollars at various points in its history.
The exchange rate of a country can be determined by using:

• 1. a fixed exchange rate mechanism;

• 2. a floating exchange rate mechanism;

• 3. a managed exchange rate.
 The fixed exchange rate system

• When the government sets the exchange rate, the

rate is said to be ‘fixed’. The government, through
the central bank, announces a value for the exchange
rate. When the rate is fixed, the government can
choose to change the rate at any time.
 Devaluation
• If the government makes a downward adjustment of the exchange rate, this is a
devaluation of the exchange rate. This means that the domestic currency has
become cheaper on the foreign exchange market.
• A devaluation is a downward movement in domestic currency, making the
currency cheaper on the foreign exchange market.

• E.g. TT$1 = US50 cents adjusted to TT$1 = US25 cents. The TT$ has become
cheaper on the foreign exchange market. We can also look at the exchange rate
in terms of the price of the US$.
 Revaluation

• If the government makes an upward adjustment of the exchange rate, this is a

revaluation of the exchange rate. This means that the domestic currency has now
become more expensive on the foreign exchange market.

• A revaluation is an upward adjustment of the domestic currency, making the currency

more expensive on the foreign exchange market.

• E.g. TT$1 = US50 cents upward adjusted to TT$1 = US67 cents. The TT$ is now more
expensive on the foreign exchange market. The revaluation will be expressed as:
US$1=TT$2 is adjusted to US$1=TT$1.50
• The foreign currency has now become cheaper on the foreign exchange market as the
domestic currency has gained value. Residents will now pay less for one US$.
 The floating exchange rate system

Under the floating exchange rate system, the forces of

demand and supply operate to determine the value of the
currency. There is no interference by the government. At
a low price, less of the currency is supplied. At a high price,
more is supplied.
Foreigners demand the domestic currency. The
foreigners fall under three main groups:

• Those who wish to buy the exports of the country

• Those who wish to visit the country
• Those who wish to invest in the country

At a low price, more of the currency is demanded. At a high price, less is

demanded.
 Depreciation (currency loses value)
• Just as for any other commodity, as demand falls or supply increases, the
currency becomes cheaper. This is depreciation of the currency.
• A depreciation of a currency is a fall in the external value of that currency
due to changes in the forces of demand and /or supply.
• When depreciation imports become costlier and as a result of this this
import will reduce and domestic goods consumption will increase.
• Exports will earn higher revenue as a result exports will increase
E.g. TT$1 = US50 cents depreciates to TT$1 = US25 cents

A change in demand in TT$ is shown in the figure below.

Price of TT$1 in US

US50 S

cents
dollars

US25

Cents D

D1

Quantity demanded and supplied

 Appreciation (currency gains value)

• As demand increases or supply falls, the currency becomes more expensive.

This is appreciation of the currency.
• An appreciation of a currency is a rise in the external value of that currency due
to changes in the forces of demand and/or supply.

• Imports become cheap; this  leads to more outflow of currency from the
country .

• Exports will lower revenue, when items are sold the country receives less.
 Quantity supplied and demanded
E.g. TT$1 = US25 cents appreciates to TT$1 = US50 cents

A change in the supply of TT$ is shown in the figure below.

Price of TT$1 in US
US50 S1

cents
dollars

US25

cents D
Exchange rate movement Fixed exchange rate Floating exchange rate
regime regmine

A fall in the external value Devaluation Depreciation

of the currency

A raise in the external Revaluation Appreciation

value of the currency