Exchange Rates & the Balance Of Payments (DP IB Economics)

The relationship between the current account and the exchange rate is dynamic

• Factors such as trade policies, capital flows, global economic conditions and investor sentiment can influence both the current account and the exchange rate 
  

The current account and the exchange rate are closely linked in international trade

• The current account records the value of a country's trade in goods/services and transfers with the rest of the world

• The exchange rate determines the price of a country's currency in relation to other currencies
  

A stronger exchange rate makes imports cheaper and exports more expensive

• When a country's currency appreciates, its exports become relatively more expensive for foreign buyers, potentially leading to a decrease in export volumes

• Conversely, imports become relatively cheaper for domestic consumers, which may lead to an increase in import volumes 
  

A weaker exchange rate makes imports more expensive and exports cheaper

• When a country's currency depreciates, its exports become relatively cheaper for foreign buyers, potentially leading to an increase in export volumes.

• At the same time, imports become relatively more expensive for domestic consumers, which may result in a decrease in import volumes 

The financial account measures the inflows and outflows of financial assets, including foreign direct investment and portfolio investment
  

Changes in the financial account can impact the exchange rate

• When there is an inflow of foreign investment into a country, it increases the demand for the country's currency, potentially leading to an appreciation of the exchange rate

• Conversely, when there is an outflow of domestic investment to other countries, it increases the supply of the country's currency in the foreign exchange market, potentially leading to a depreciation of the exchange rate
   

The exchange rate influences the attractiveness of a country for foreign investment

• A stronger exchange rate makes foreign investments more expensive in terms of the investor's home currency, potentially reducing the appeal of investing in that country.

• A weaker exchange rate can make a country's assets more affordable for foreign investors, potentially increasing the attractiveness of investing in that country