I literally don't understand how exchange rate and interest rate link. How does an increase in interest rate increase exchange rate??? why are they directly proportional??? For AS level
I literally don't understand how exchange rate and interest rate link. How does an increase in interest rate increase exchange rate??? why are they directly proportional??? For AS level
OK. Think about it this way. If you have a hundred pounds which today is the equivalent of $100 ( just pretend) and interest rates in the UK are 1% whereas they’re 10% in the US, where would you want to put your money? If you leave it in £´s , at the end of the year you’ll have £101 pounds, but if you convert it to $´s at the end of the year you’d have $110. So which currency would most people want?? The answer is $´s . However when the demand for something increases and there is a limited supply what happens ?? The price, or in this case the exchange rate increases so that $´s become more expensive to buy. So instead of needing £1 to buy $1 you now need £1.10. Obviously things are not that exact in real life because other factors influence exchange and interest rates, but other things being equal that is the the logic behind the relationship.
OK. Think about it this way. If you have a hundred pounds which today is the equivalent of $100 ( just pretend) and interest rates in the UK are 1% whereas they’re 10% in the US, where would you want to put your money? If you leave it in £´s , at the end of the year you’ll have £101 pounds, but if you convert it to $´s at the end of the year you’d have $110. So which currency would most people want?? The answer is $´s . However when the demand for something increases and there is a limited supply what happens ?? The price, or in this case the exchange rate increases so that $´s become more expensive to buy. So instead of needing £1 to buy $1 you now need £1.10. Obviously things are not that exact in real life because other factors influence exchange and interest rates, but other things being equal that is the the logic behind the relationship.