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Changes in exchange rate –
Here we should point out that some firms face operating exposure without ever dealing in foreign exchange. For example, restaurants in US resorts those are visited by foreign tourists gain or lose customers according to the exchange rate. US restaurants also gain or lose domestic customers with changes in exchange rates that affect the vacation destination of American travelers: exchange rates influence whether American tourists travel abroad or vacation at home. This exposure happens despite the fact that the US restaurants are generally paid US dollars by diners and pay for ingredients, labor, rent, and interest in US dollars. Similarly, industries which compete with imported goods face operating exposure. For example, US firms that supply beef to US supermarkets and that never see foreign exchange can find stiffer competition from foreign beef suppliers when the US dollar gains against other suppliers’ currencies, lowering prices of the non-US product. Any company that uses inputs that are internationally tradable, whether imported or not, will find costs changing with exchange rates.
Recent developments in the exchange rate system, were marked by large exchange rate changes related both to differences among the internal monetary developments in several major countries and to large shifts in current account balances. In assessing these developments, Fund surveillance over exchange rate policies of members must take into account not only the need for achieving external balance but also the political and economic desirability of meeting domestic objectives. Analysis of the evolution of exchange rates among the industrial countries is complicated by the interdependence among changes in exchange rates, monetary and other policies undertaken by those countries, and other factors affecting their current account positions. While most countries in the world, including most of the smaller industrial countries, peg their currencies to one of the major currencies or to baskets that include these currencies, the rates among the major currencies themselves—except for rates between currencies of participants in EMS intervention arrangements—are subject to wide variation and are determined principally by financial policies and current account developments in the countries concerned.
Monetary policies and current account positions have both a direct impact on the demand for, and supply of, the domestic currency in the foreign exchange market and an indirect effect brought about by altering the expectations of investors with regard to future exchange rates and thereby inducing portfolio shifts among assets denominated in different currencies. Exchange rate movements, in turn, have a major impact on current account developments, which tend, however, to be more heavily influenced in the short run by cyclical changes in real income. The real changes in U.S.
interest rates which is short term over the past year and a half have resulted in large variations in interest rate differentials between the United States and other major industrial countries. These movements have been associated with fluctuations in U.S. dollar exchange rates taking place over the same period.