Explain the major factors that influence the kind of exchange rate system a country has?

Answer 1

Foreign Exchange being a commodity like any other commodities tends to fluctuate in price from time to time. There are various factors that cause the fluctuation in the rates of exchange; * Rising interest rates cause 'hot' money to flow into the economy, therefore the demand of the domestic currency increases, and thus the currency appreciates in value and demand. * Relative inflation rates, affect the economy's international competitiveness, so if the economy is experiencing higher inflation rate than its trading partners, its purchasing power is eroded and thus the demand for that particular currency. * Speculation normally affects the currency value when there is belief that a particular economy is 'over heating' and that soon there will be devaluation, then chances are high that, speculators will pull out their monies, causing there to be more supply than demand on the Forex for that particular currency, hence its depreciation. * International trade affects the value of a currency, particularly through how much export or imports a nation may have, countries selling so many goods and services to others, tend to appreciate their Forex standards and those importing highly normally have their currency fall in value since they are spending more to their trading partners than they gain from them. * Political and psychological factors are believed to have an influence on exchange rates. Many currencies have a tradition of behaving in a particular way for e.g. Swiss franc as a refuge currency. The US Dollar is also considered a safer haven currency whenever there is a political crisis anywhere in the world. * Governments sometimes participate in the Forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. However, the size and volume of the Forex market makes it impossible for any one entity to "drive" the market for any length of time.