# The Currency Value

On what basis, The value of any currency changes:

• Does it depend on re-paying the loans.

• Or it depends on trade & exporting.

(e.g. The "Dollar" equals 13 Egyptian pounds... What's the reason? Is it because "Egypt" is keeping borrowing without repaying its debts or because, What?

• Note: Kindly, If my post violates the web-site rules... Please, Edit it instead of putting it [on Hold]... I don't mind to edit my posts... So that, It becomes in keeping with the web-site rules.

In addition to Lassie Fair's answers, you may study separately the short and long term currency rate movements. The text below refers to some of the models mentioned in literature: are they right or even helpful, well it depends... Wikipedia has a nice article on foreign exchange markets including a section on determinants of exchange rates.

## Short term

Random walk seems to characterize many exchange rate movements better than the models mentioned below. Long term equilibrium values may anchor the exchange rate movements but deviations from equilibrium can take large, long and chaotic path.

## Long term

Models use fundamental variables like relative money supply, interest rates, inflation rates, economic grothw rates and currency account balancies. You see nominal exchange rates but real variables influence. Further, expectations (e.g. a trending GDP or inflation) and relative movements of rates, influence.

Many models use or are based on international parity conditions:

1. Ex Ante Purchasing Power Parity (PPP on wikipedia)
2. International Fisher Effect
3. Uncovered Interest Rate Parity
4. Forward Rate as an Unbiased Predictor
5. Covered Interest Rate Parity
6. Fisher Effect
7. Real Interest Rate Parity

Rosenberg {2} has a nice picture that relates 1.-5. to each other. Wikipedia has a page on Interest Rate Parities. I'll describe (very) shortly some of above models. The third means that country with higher interest rate is expected to see the value of its currency depreciate (yield differential is offset by currency moves). The first one takes a look of the inflation differential and PPP can come in many forms (e.g., absolute, relative, ex ante): equilibrium exchange rate between two countries is determined by their national price levels. Over long term, many believe that exchange rates mean revert toward their PPP-based values.

The seventh says that real interest rates converge to the same level accross markets and nominal yield differential (between countries) is determined by expected inflation differential (the sixth item above).

The above conditions are linked to each other. For other models, see the wiki-page mentioned in the beginning.

## Assessing Equilibrium Level

IMF (see IMF Eqiulibrium Exchange Rates: Assesment methodologies and IMF financies) makes assesments of equilibrium levels regularly. (I couldn't find a link to the latest assements, if you have, please could you put one e.g in the comments.) Other institutions also do make assesments.

Without explaining,the methods include e.g.:

1. Macroeconomic balance approach
2. External sustainability approach
3. Reduced-form econometric model

## Determinants

Balance of payments (investment and financing decisions) usually tends to affect exchange rates in the short term. And also in the long run, e.g. long term and large budget deficits could lead to currency decline. Supply and demand, debt sustainability and portfolio balance affect. The last one refers to financial wealth transfer between nations due to the current account imbalancies.

Further, governments apply monetary and fiscal policies. Mundell-Fleming model describes, how expansionary or restrictive monetary policies with expansionary or restrictive fiscal polycies affect currency rates. There are at least two flavours of the model: high capital mobility and low capital mobility. Unfortunately, the wiki-page does not give a good summary of the effects (please, take a look of Rosenberg):

In high capital mobility:

• expansionary monetary and restrictive fiscal policy leads to domestic currency depriciation
• restrictive monetary and expansionary fiscal policy leads to domestic currency appriciation
• other pairs of policies are ambigouous

In low capital mobility

• expansionary monetary and expansionary fiscal policy leads to domestic currency depriciation
• restrictive monetary and restrictive fiscal policy leads to domestic currency appriciation
• other pairs of policies are ambigouous

Monetary models (e.g. Dornbusch Overshooting), in turn, take that output of the nation is fixed and monetary policy affects exchange rates first.

And what central banks then do? Many set interest rate target and not money supply target. (How do you relate the qe's to that?) Anyhow, the Taylor Rule is used to set interest rate target. And then there are interventions and controls to manage exchange rates.

What factors there are that affect capital flows (and thus supply and demand)? E.g. economic management cabability of policymakers, inflation and inflation volatility expectations, currency rate flexibility, current account balance changes, debt changes, currency reserves, privatization, liberalization, regulations and controls and changes in them, economic growth, fiscal positions, and ratings.

Hope this answered at least partially your question and that it gives you pointers to go forward.

{2} Exchange Rate Determination: Models and Strategies for Exchange Rate Forecasting, Rosenberg, Michael R. 2003

National currencies increase or decrease in price relative to other national currencies due to the demand for those currencies and their supply.

The supply and demand for currency is dependent on many different factors. The main factors are the needs of trade, the policies of the authority that issues the currency, and the perceived stability and predictability of that authority.

For example, if a merchant wants to buy a good that comes from the country in question, then they might need to acquire the currency of the country. This will increase the demand for the currency and consequently its price.

On the other hand, if the country had a revolution or the authority that issues the currency began to act in an erratic way, then that could undermine confidence in the currency, decreasing the demand and the price.