Changes in Supply and Demand of Currencies

Changes in Supply and Demand for a Currency (AO2)

• Foreign demand for exports / domestic demand for imports

  • • When consumers from your country want to buy products from another, they will first have to sell your country's currency in exchange for the other country's currency before they can buy the product.

    • This means demand for the other currency increases, and that the supply of your currency increases.
      
      

• Foreign Direct Investment (FDI)

  • • FDI refers to international firms investing abroad, usually into factories to decrease costs of production.

    • Inward FDI means a firm invests into your economy (money goes in). More demand for domestic currency.

    • Outward FDI means a domestic firm invests in another economy (money goes out). More supply of domestic currency.
      
      

• Portfolio investment

  • • Some people/firms/governments may purchase financial investments from abroad. This includes stocks, options, and bonds. 

    • Inward investment means someone from abroad wants to purchase investments in your country (money goes in). More demand for domestic currency.

    • Outward investment means someone from your country wants to purchase investments abroad (money goes out). More supply of domestic currency.
      
      

• Remittances

  • • Remittances refers to money sent from people working abroad sending their money back to their home country. 

    • More demand for the home currency, while more supply of the original currency.
      
      

• Speculation

  • • Speculation here refers to the purchasing of a currency in hope that its value will increase.

    • More demand for investment currency, while more supply of the original currency.
      
      

• Relative inflation rates

  • • High inflation rates will make the country's exports less competitive, which will reduce exports, which in turn reduces the demand for the country's currency. 

    • Additionally, if inflation is hurting a currency, investors may sell this currency in exchange for a more stable one.

    • More demand for stable currency, while more supply of the inflationary currency.
      
      

• Relative interest rates

  • • If banks in a country offer high interest rate deposits, investors may put money in these bank accounts, in the form of local currency.

    • More demand for high interest rate currency, while more supply of the original currency.
      
      

• Relative growth rates

  • • High economic growth -> inflation -> central bank increases interest rates -> investors see high returns on bank deposits -> more money is put into local banks

    • High economic growth -> more confidence in the economy -> more investment from other countries

    • More demand for high growth economy's currency, while more supply of the original currency. Here, we assume the economic growth would increase the inflation rate.
      
      A counterpoint that can be raised is that it could actually have the opposite effect:
      
      

    • High economic growth -> more net imports from other countries as demand outweighs supply

    • More demand for other foreign currencies, while more supply of the high growth economy's currency.
      
      

• Central bank intervention

  • • Some countries may restrict the buying and selling of their currency, which reduces the effect of the aforementioned factors.