Many factors affect the exchange rate between two currencies, the 3 most important ones are discussed here!!
With the rapid increase in globalization connecting different parts of the world the globe is getting smaller and smaller day by day. Gone are the times when the economy sustained itself by restricting trade within its boundaries. The picture of imports and exports is constantly jutting out. This makes the concept of “exchange rate” even more important.
Exchange rate between two currencies determines how much a country is required to pay for imported goods and also how much it is required to receive for the exports. Suppose you are a citizen of USA, and say the demand for US dollar due to an economic boom increases than its supply, the value of dollar rises and when the supply is more than the demand the value of dollar falls.
If the two countries heavily trade with each other, then the general notion of “exchange rate” plays a vital role.
The factor of demand and supply is really a crucial one because these economic parameters further depend on many factors like the interest rates, inflation etc.
If the interest rate in USA say is higher than in other countries people will prefer to invest more in the US owing to higher rate of return on their assets. This increases the demand for dollar. Similarly, if the interest rate is lower in USA as compared to other countries investment will be low, thereby decreasing the supply of dollars and thus, its value.
What if the high interest rate is accompanied by high inflation rate??
In this case the investors will not prefer investing in USA considering that the value of the dollar can be eroded any time due to higher inflation rates.
Thus, the above are the 3 most critical factors affecting the exchange rate between two currencies.
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