(A) Exchange rate is defined as the charge for exchanging currency of one country for currency of another. The level at which a currency is valued at depends on supply and demand. If there is a shortage of the currency then it is scarcer and the value increases. For example China keeping back trillions of American dollars means that the dollar appreciates. If there is no demand for the exchange rate then the quantity needed is reduced and this shifts in demand. As shown on diagram 1. If demand is low it reduces output and price level. The value of a currency is generally measured against its trading partners.
The level of demand depends on how much of the currency other countries want to buy. If a country wants to do a lot of trading with that currency then they will buy more if and the demand and the price of it rise. For example the dollar accounts for 80% of world trade and therefore is worth a lot compared to other weaker currencies. If the export of goods falls then demand for the currency falls as a reaction of supply, as shown in diagram 1. The same is true if world imports fall because global demand is reduced.
If a currency in the past has been unstable and volatile then the value of it will fall. This is because if there is little confidence in, fewer people will buy the currency as they can not be certain of the value it will have in the near future. This reduces investment into the country and in the long run reduces output levels.
Another factor in the value of a currency is currency manipulation. If the government use this form of monetary policy then can alter and hold the value of their currency artificially. For example the Chinese are doing this. Another aspect of monetary policy that determines the exchange rate is interest rates. If interest rates are high then this will increase returns and investment. This means that more money will flow into the economy and the more of its currency will be bought in order to invest in the economy. If...