Exchange rates

Exchange Rates


  • An exchange rate is the price of one country’s currency in terms of another.
  • The exchange rate is determined by the demand and supply of currencies on the foreign exchange market.

Types of Exchange Rates

  • Floating exchange rates: These rates are determined by market forces of supply and demand and can change freely.
  • Fixed exchange rates: In this case, the government or central bank sets the exchange rate and intervenes in the currency market to maintain it.
  • Managed float exchange rates: A combination of floating and fixed rates, the central bank allows the exchange rate to fluctuate within a certain range.

Factors Influencing Exchange Rates

  • Demand for goods and services: If a country’s exports increase, demand for its currency will rise, leading to an appreciation in its exchange rate.
  • Interest rates: Higher interest rates attract foreign capital, increasing demand for the home currency and causing an appreciation.
  • Inflation: Lower inflation rates lead to an appreciation in the currency, while higher inflation leads to depreciation.
  • Political stability: Countries with a stable political and economic environment are seen as safe havens, attracting capital and causing currency appreciation.

Impacts of Exchange Rate Changes

  • Exports and Imports: A depreciation makes exports cheaper and imports dearer, potentially improving the balance of trade, while appreciation has the opposite effect.
  • Inflation: A depreciation of the currency can cause imported inflation, as the cost of imported goods and raw materials rise.
  • Economic growth: An appreciated currency can reduce the competitiveness of domestic industries, potentially slowing economic growth, while depreciation can stimulate growth by boosting exports.

Role of Central Bank

  • Central banks can intervene in the currency markets to manage the exchange rate.
  • This can be achieved through buying or selling domestic currency, altering interest rates, or adjusting reserve requirements.


  • Successful management of exchange rates can be challenging due to the multifaceted nature of global financial markets and the influence of international events.
  • Frequent fluctuations in exchange rates can create uncertainty for businesses involved in international trade.
  • If a country is persistently running a trade deficit, attempts to artificially bolster the value of its currency may ultimately fail.