EXCHANGE RATES

Exchange Rates

Exchange Rates

Introduction

Exchange rate is the worth of one currency in terms of the other. It can also be explained as the value of foreign currency in terms of host currency. There are several factors that have an impact on the exchange rate of a country for example inflation can either appreciate or depreciate the value of the currency. The increase in the value of a currency's exchange rate means appreciation of the currency and decrease in value is termed as depreciation of the currency (Bodnar & Gentry, 1993 Pp. 29-45). The report will find out the effects of floating exchange rate on the economic growth and the inflation rate. It will also define the effects of changing exchange rate on the businesses in different countries.

Discussion

Relationship of Exchange Rate and Economic Growth

Exchange Rate (ER) is the price of one currency in relation to another. It expresses the national currency's quotation in respect to foreign ones. Compared to nominal, Real Exchange Rate (RER) is often acknowledged as an important macroeconomic policy variable in the sense that it indicates a country's international competitiveness. The RER is the Nominal Exchange Rate (NER) adjusted for price changes (inflation) in the domestic relative to those of trading partners. The NER management depends on the exchange rate and the exchange rate is influenced, among others, by NER. The objective of this study is to examine the effect of the exchange rate as one of the monetary policy tools on economic growth by considering it in both nominal and real term, and at the same time, to look for the causal pattern between both exchange rate and economic growth in Malaysia using annual data over the period 1971-2009. Do these exchange rates give similar effects to economic growth? Is the real surpassing the nominal in terms of its role as a monetary policy tool? Certainly these questions need further investigation.

International exchange rates are an important indicator of the overall state of an economy. Domestic exchange rate, for instance, provides information about the differences in economic activity between regions and is considered as important economic barometers or indicators. Based on economic theory, the fact that the exchange rate as a monetary variable should affect long run growth is seen as somewhat puzzling, especially the negative effect. As found in most previous literatures, two channels have been suggested through which exchange rate (common currencies) should positively affect growth. A common currency lowers currency risk and hence interest rates, thus spurring investment and growth; and a common currency could impact growth through lowering the transactions costs associated with international trade. However, increased trade has sometimes but not always been found to rise economic factors (Bodnar & Gentry, 1993 Pp. 29-45).

Exchange rate can be used as one of the macroeconomic policies. In addition, real appreciation of the exchange rate should not be allowed to exceed equilibrium level in order to not derail export at the advantages of massive importation of goods and eventually boost the economic growth (output ...