If China Adopted a Free Floating Exchange Rate Policy

If China Adopted a Free Floating Exchange Rate Policy

Introduction

China has regulated its foreign exchange rates for a while now. It has purposely kept it undervalued. This paper will analyze the probable outcome if China adopts a free floating exchange rate regime. This analysis will be made using the factors that influence fluctuations in foreign exchange.

Discussion

Exchange rate is a term used to describe the rate between two different currencies. Also, known as the foreign exchange rate, it is also considered to reflect the overall value of a country's currency. The said rates are determined in the foreign exchange market. This market is open to buyers and sellers who can trade continuously; 24 hours a day except on weekends.

Many factors affect foreign exchange rates. A country that has lower inflation rates; has higher purchasing power with respect to other countries. This also means that the currency has a rising value. Countries that have higher inflation rates have lower valued currency. Another way to alter a country's forex rates is to manipulate the interest rates. This directly affects inflation rates and currency value. High interest rates attract foreign capital. People see that there is a chance to get a higher return, because of the high interest rates, and invest in that country. Foreign investment causes the exchange rates to rise. A notion that must be kept in mind is that if interest rates and inflation rates are both high, this can have a detrimental effect.

Governments are often seen engaging in large scale deficit financing. They do this to pay for various projects. These can be public sector projects of just government spending. This may stimulate the economy, but if the deficit is too large, it will scare off foreign investors. As a rule, the larger the ...