What moves exchange rates

What moves exchange rates?

In the short run:

• Speculation: if investors expect a currency to rise, they buy it now, and their buying pushes its price up. The expectation fulfils itself.
• Interest rates: higher interest at home attracts foreign funds, which raises demand for the home currency, so it appreciates.
• Income: if a country's income grows faster than the world's, its imports grow faster than its exports, so its currency tends to depreciate.

In the long run: purchasing power parity (PPP). The idea is that the same good should cost the same everywhere, once prices are converted. So the exchange rate follows relative prices.

Example: a pair of shoes costs $20 in the US and ₹1,600 in India. PPP rate = 1,600 ÷ 20 = ₹80 per dollar.

If Indian prices rise faster than US prices, the rupee must depreciate. If Indian prices rise by 25% (shoes ₹2,000) while US prices stay the same, the PPP rate becomes 2,000 ÷ 20 = ₹100 per dollar.

PPP is useful for long-run predictions, not for day-to-day movements.