Exchange rates
Exchange rate systems
- An exchange rate is the price of one currency in another.
- floating — set freely by demand and supply of the currency.
- fixed — held at a set value by the central bank (it buys/sells the currency).
- managed — mostly floats, but the central bank steps in to steady it.
Practice
A floating exchange rate is set by:
A floating rate moves with currency demand and supply; a fixed rate is held by the central bank.
Appreciation and depreciation
- appreciation (rise): exports become dearer abroad, imports cheaper.
- depreciation (fall): exports become cheaper, imports dearer.
- A depreciation can raise export sales and cut imports (helping the current account) — but it can raise inflation (dearer imports).
Practice
A depreciation of the currency makes the country's exports:
Depreciation makes exports cheaper and imports dearer, which can help the current account but raise inflation.
Practice
An appreciation makes imports cheaper.
A stronger currency buys more abroad, so imports become cheaper (and exports dearer).
You've got it
Key idea
- systems: floating (market), fixed (central bank holds it), managed (mostly floats)
- appreciation → exports dearer, imports cheaper; depreciation → exports cheaper, imports dearer
- a depreciation can help the current account but raise inflation