International finance and open economy macroeconomics

Abstract

This chapter explores the market for foreign exchange and how the supply and demand for foreign currency affect exchange rates. The variation in approach depends on a country's tolerance for the instability that can come from rapid swings in exchange rates and international investment flows and the country's willingness to utilize government intervention to achieve greater stability. In a foreign exchange market, the price of a currency is the exchange rate, which is the amount of a foreign currency that one unit of the domestic currency can purchase. The demand curve in the foreign exchange market for the dollar consists of UK citizens, banks, and businesses that are exchanging pounds for dollars. The supply curve slopes upward because as a currency appreciates in value, foreign goods and assets get cheaper, so home country citizens supply more home currency to obtain more foreign currency, which they use to buy more foreign goods and assets.

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