The exchange rate, also known as exchange rate, is an indicator that states the number of units of one currency that are needed to obtain one unit of another. That is, it is the ratio of proportion that exists between the value of two currencies.
In other words, the exchange rate is the amount that must be paid for a foreign currency unit and it fluctuates depending on the supply and demand of the foreign exchange market. It is the relationship that exists between two currencies of two countries.
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When the supply is greater than the demand, that is, there is an abundance of dollars in the market and few buyers, the exchange rate falls and rises when the opposite occurs. That is, when there is a shortage of dollars and many buyers.
In most of the countries of the world, the US dollar is used as the reference currency to define the exchange rate in commercial transactions. This currency is used by many countries as a reserve currency and what gives great importance to that currency.
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In this article you will find:
Exchange rates
The supply and demand of foreign exchange determines the type or exchange rate in the foreign exchange market. These arise from the need to relate the currencies of different countries, which is the way for international economic transactions. Among them we find two exchange rates "nominal" and "real".
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Nominal change
The exchange rate or rate "nominal”Is the representation of the value of a unit of currency from another country expressed in terms of the national currency. It is a relative price, and its changes also influence the prices of goods and services produced in the country with respect to those produced in another.
- It is the relative price of the "currency" of two countries.
- It is the one to which currencies are bought or sold in the market.
- It is the official quotation of the exchange rate.
Real change
The exchange rate or rate "real”Is the price of goods from the foreign country expressed in terms of local goods. Both brought to the same coin.
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If the real exchange rate rises, domestic goods will be relatively more expensive and foreign goods cheaper. If, on the other hand, the real exchange rate falls, domestic goods will be relatively cheaper and foreign goods then more expensive.
- It is the price of the "goods" of two countries.
- It is the purchasing power of a currency over the goods of two countries.
- It reflects the true purchasing power of the national currency against one or more foreign currencies.
- It represents then, the real purchasing power taking into account the prices of the country of another currency.
Exchange regime
They are the policies adopted by a country regarding the value of its currency and determination of the exchange rate. Of course, this value, like that of goods and services, can be influenced, and even intervened and fixed, by governments to favor their economy.
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An exchange rate regime is based on three types of exchange:
- Fixed exchange rate: refers to the anchoring of one currency to the value of another, but in a direct and strict way. Monetary policy is derived from the main currency. Therefore, changes in its relationship and value are not allowed.
- Flexible exchange rate: is when in a foreign exchange market changes in the value of the currency can occur as a result of inflation or some commercial activities between several countries. Restrictions can be set to moderate these changes.
- Fluctuating exchange rate: in this mixed system there may be restrictions, but flexible depending on supply and demand and respecting established margins which are generally 1% to 3% to help stabilize the market exchange rate.
Determinants of the exchange rate
The exchange rate is determined by several factors. Some of them are mentioned below.
- Differential inflation: Typically a country with a low inflation rate exhibits a high value of the currency, as well as an increase in purchasing power relative to other currencies. Countries with high inflation typically depreciate their currency in a similar way to the currencies of their trading partners.
- Differential interest rate: It is the difference in the interest rate between two currencies. inflation, the exchange rate, and the interest rate are closely related. When being manipulated by the central bank, it influences the inflation rate and the exchange rate, and the change in the interest rate impacts inflation and the value of the currency.
- Current account deficit: The current account is the balance of the business between a country and its trading partners. Payments, interests, goods, dividends and services are reflected. The deficit is a current account that shows that a country is spending more than it earns and this causes it to go into debt.
- Public debt: Countries with large public debt have problems meeting their payment commitment in both the public sector and private debt. Although this stimulates the domestic economy, it is a less attractive country for foreign investment.
Importance of the exchange rate
The exchange rate allows comparing and comparing the prices of goods and services produced in different countries. It also helps to determine the real cost, that is, the amount of money that a thing costs in currencies used in international transactions and purchased by the country.
It allows converting the prices expressed in foreign currency into the respective prices in the national currency. Helps determine the value of one currency in terms of another, the exchange rate helps define the health of the nation's economic system and therefore the well-being of the people who reside there.
Finally, trade (import and export) is influenced by exchange rates since most consumers only take into account the price of goods in their own currency.
