Macroeconomics
Factors that cause an increaseordecreaseinthesupplyofacurrency,andconsequently,ashiftinits curve, primarily depend on how much holders of that currencywantgoods,services,andassetsfrom other countries. As we explain thesefactors,wewillconsistentlyusethesupplyoftheU.S.dollarasan example. ● DomesticDemandforImports: Whenresidentsofacountrydemandmoreimports(goodsand services including tourism), the supply of their domesticcurrencyincreasestoexchangeitfor theforeigncurrencyofthecountrytheyarebuyingfrom,andviceversa. Forexample,whenmore Americans visit Europe for vacation, the supply of the U.S. dollar increases to buy Euros. ● DomesticDemandforForeignFinancialAssets: Whenlocalspurchaseforeignfnancialassets suchasstocksandbonds,thesupplyoftheirnationalcurrencyincreasestoexchangeitforthe foreign currency of the assets, and vice versa. ● Domestic Firms Invest Abroad: Whendomesticfrmsestablishandinvestabroad,theyadopt the currency of the host country which increases the supply of their domestic currency.
● Quality and Price of Foreign Products: As foreign products become more competitive in terms of quality and price, people will import more of them. This increases the supply of the local currencytoexchangeitforthecurrencyof the country that is exporting. ● Foreign Real Interest Rate: When real interest rates abroad increase relative to the domestic
ones, foreign fnancial assets become more attractive, hence increasing the supply of the domestic currency to invest in foreign assets. For example, when the real interest rate in EuropeancountriesishigherthanthatintheU.S.,AmericanpeoplewillsupplymoreU.S.dollars to buy Euros and invest in European fnancial markets. ● Speculation: Whenpeopleexpectadecreaseinthevalueoftheircurrency(depreciation)they supplymoreofittobuyothercurrencies,andviceversa. Forexample,expectationsofadropin the value of the U.S.dollarrelativetotheEuroencouragedollarholderstoselltheircurrencyin return for the Euro which will become more valuable. ● National Income Level: A high national income level allows people to import more and vice versa. When imports increase, the supply of the domestic currency increases. Anincreaseinthesupplyofacurrencyreducesitsvalue(causesittodepreciate)intheforeignexchange market.Conversely,adecreaseinitssupplyraisesitsvalue.Inaddition,whenthedemandofacurrency quoted against another increases, the supply of the other currency increases, and vice versa.
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