Exchange rate determination of indian currency ?
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How exchange rate of indian currency is determined. What are the practical factors that affect the exchange rate. How indian currency rate goes up and comes down (with respect to US dollar)
and what are the practical reasons behind it. How bank deals with foreign exchange and how RBI interfere in it ?
Exchange rate determination of indian currency ?According to popular thinking a widening in the balance of payments deficit raises the demand and lowers the supply of foreign currency and this leads to depreciation of domestic currency.
This theory suggests that if local prices are going up, for whatever reasons, this gives rise to more imports and fewer exports i.e. the widening in the balance of payments deficit. In other words if rises in domestic prices exceed rises of prices abroad, other things being equal, this will cause balance of payments deficit and domestic currency depreciation.
The Austrian School, led by the late economist Ludwig von Mises, however, holds that this cannot be so. As long as the money supply is not expanding peoples monetary income will not increase. Consequently they would be forced to restrict their consumption either of imported or domestic products in response to price rises. In the first case imports will drop and in the second case exports will increase. Thus the balance of payments will be brought to a 锟絝avourable锟?state.
The Austrian view holds that the exchange rate of a currency like the price of any other good is determined by its relative scarcity in relation to the demand to hold currency. Just like any other good, both supply and demand determine the price, or the exchange rate of a currency. According to Mises the rate between two currencies will tend to equal the ratio of their purchasing power. In other words it is the relative purchasing power that determines the currencies rate of exchange.
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