Exchange Rate

Is the price of the domestic currency in terms of foreign currency:

# units of foreign currency / 1 unit of domestic currency if domestic currency is US dollar: # Yen / $1

9/8/15: ¥119 / $1 (or, $0.0083 / ¥1)

Euro: €0.89 / $1 (or, $1.12 / €1)

If it takes more foreign currency to buy $1, “dollar appreciates” (or “revalues”)

If it takes less foreign currency to buy $1, “dollar depreciates” (or “devalues”)

If domestic currency appreciates, exports become more expensive to ROW, imports become cheaper, and net exports (and probably CA) decrease

If domestic currency depreciates, exports become cheaper to ROW, imports become more expensive and net exports (and probably CA) increase

Foreign Exchange Market

Draw foreign exchange market, with Quantity of Domestic Currency on horizontal axis and Price of Domestic Currency in terms of foreign currency on vertical axis

Assets purchases and sales usually drive the exchange rate, at least in the short and medium run

So if domestic interest rates rise, domestic assets look more attractive than foreign assets to both domestic and foreign residents

So the demand for domestic assets goes up, foreigners sell their currency to buy our domestic currency, and the demand for domestic currency rises

As demand for domestic currency shifts to right (because of higher domestic interest rates), the domestic currency appreciates while the foreign currency depreciates

If the foreign country has borrowed dollars, now it takes more domestic currency to buy one dollar; firms earning the foreign currency now may not be able to pay their debts of dollars, and may go under

Since the emerging economies face declining demand for their commodity exports because of the slowdown of the Chinese economy, and because the US may soon raise interest rates, which will appreciate the dollar (and depreciate emerging currencies, the emerging economies are in trouble: Brazil, Argentina, Mexico, Colombia; Malaysia & Indonesia; South Africa & Turkey; Sub-Saharan Africa;

The oil exporters are especially hard hit: Russia, Venezuela, Middle East