Exchange Rates

Definition

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.

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.

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.

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.

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.