Compare how exchange rates are determined in Singapore and USA.

Intro:

Recognize that there are some similarities and differences between how exchange rates are determined in both Singapore and USA. The similarities can be broadly classified as the similar impacts that the free market mechanism has on both exchange rates and the key difference is the different exchange rate systems for both countries.

Body:

Similarities:

Both countries’ exchange rates are subjected to market forces where similar factors affecting the demand and supply of currencies will affect the equilibrium exchange rate of the country.

When the currency markets are subjected to changes in demand or supply, the price mechanism will work to clear any surplus (downward pressure on price when there is a fall in DD or a rise in SS) or any shortages (upward pressure on price when there is a rise in DD or a fall in SS).

The demand curves of both countries’ currencies are determined by the amount of inflow of currency and the supply curves of both countries’ currencies are determined by the amount of outflow of the currency in the BOP. There are factors that will affect the market for currencies that are common across both countries. These can be broadly classified into factors affecting the current account and factors affecting the capital account. (1-2 examples to illustrate similar factors affecting DD and SS of the currency is sufficient)

• Current Account factors
  • Factors that affecting the exports (affecting currency DD) and imports (affecting currency SS) of each country’s goods
    • Changes in comparative advantage between countries will affect the X and M over time.
    • Changes in local and foreign income will affect the X and M of goods respectively.
    • FTAs established with other countries will likely increase X and M
  • Property income and unilateral transfers. Inflow of income will affect currency DD and outflow of income will affect currency SS.
    • Both countries are open to labour flows and also have share of their population that working overseas. When income is repatriated from these countries to other countries, there will be a change in demand (when income is sent in) and supply of the currency (when income is sent out)

• Capital Account factors
  • Factors that can influence the flow of LT capital. Inflow of LT capital will affect currency DD and outflow of LT capital will affect currency SS.
    • Business conditions like government stability, infrastructure, cost conditions etc will affect FDI flows in both countries.
  • Factors that can influence the flow of ST capital. Inflow affects DD and outflow affects SS
    • Hot money flows can be influenced by speculation on currencies, interest rates relative to the world, development of financial sector, attractiveness of shares and bonds in both countries.

Differences

Even though both countries are affected by market forces arising from the DD and SS of their currency, a key difference that students should cover is that both countries have a different exchange rate system, which will affect how exchange rates are determined by both countries

• Differences in exchange rate system
  • USA has a free-floating exchange rate. Therefore, its exchange rate is left to market forces to determine. The factors mentioned above will cause demand and supply for its currency to change and the price mechanism will then bring its currency market to a free-floating market equilibrium.
  • SG has a managed float system for its exchange rate. While the above demand and supply factors will still play a part in determining SG’s exchange rates, the MAS only allows for the currency to float within a predetermined band, which gradually appreciates over time. When market forces causes the e/r to be above the band, MAS will sell SGD and buy foreign reserves, increasing supply of SGD to keep the e/r within the band. When market forces causes the e/r to be below the band, MAS will buy SGD and sell foreign reserves, reducing supply of SGD to keep the e/r within the band.