Consider the extent to which the theory of exchange rates explain the Essay

Consider the extent to which the theory of exchange rates explain the performance of the US$ in recent years - Essay Example Historically, the most common fixed exchange rate used to be gold standard, until 1850s where, one ounce of gold was taken as worth $20 (U.S dollars) and 4 pounds of sterling, leading to an exchange rate of $5 of every pound. On the other hand, an exchange rate is said to be flexible, variable or floating when two or more countries come into agreement of letting the international market forces govern the rate through the forces of demand and supply. In this case, the rate would vary with a country’s imports and exports. According to Marazzi, Mario & Sheets (2007) majority of the trade economies such as US, Europe, Japan and China takes place with variable and flexible exchange rates that vary within comparatively fixed limits. Therefore, there is a strong relationship between the US dollar rate of exchange and all the major foreign currencies with an exception of those from the developing countries. It should be taken into account that with respect to the US stock market, this correlation is equilibrium with all parties being significant to its sustenance. The key reason for this causal relationship is that every investor view U.S Dollar as a negative beta which should always be falling in value whenever there is an upsurge of the value of stock market and should be increasing in value whenever there is a decrease in value of the stock market. ... Bilateral rates provide the comparison of the rate of exchange of currency of a country with that of another currency of a different country. For instance, one sterling pound can exchange for $1.50. On the other hand, multilateral exchange rate is the worth of a currency compared to more than one currency, unlike bilateral rates that give the comparison of only two countries or nations’ currency. Economists and market analysts determine multi-lateral rates to decipher averagely what is taking place in the exchange rate arena. This is got through the adoption of an index that denotes variations in one currency as compared to a pool of other currencies. In the past few years, the US exchange rate has constantly made the US dollar to fall rapidly against other well-known currencies such as euro-zone currencies with the lowest limit being recorded in 2008. Exchange Rate Policy The exchange rate based on any country’s economy impacts either negatively or positively the aggre gate demand via its effects on imports, exports and the extent at which policy makers can exploit this correlation. Besides, Exchange Rates can be operated as a form of monetary policy for guiding the balance of trade of many nations. In ideal situation, rates should always be held down to stimulate and scale up exports with a view of lessening inflationary pressure rocking a country’s economy. While the Bank of America does not particularly target the exchange rate, the MPC would always focus on the trend of exchange rates. In essence, during times of inflation pressure, the MPC would prefer a comparatively elevated rate given that this would lessen the price of import commodities and services and also will always help in absorbing the