Foreign exchange rates
How the rate is set
- The exchange rate is the price of one currency in another (e.g. 1 pound = 1.30 dollars).
- In a floating system it's set by the demand for and supply of the currency.
- More demand for a currency (to buy its exports, or invest there) raises its rate — e.g. higher interest rates attract savers.
Practice
In a floating system, the exchange rate is set by:
A floating rate moves with currency demand and supply, like any market.
Appreciation and depreciation
- appreciation (rises): exports become dearer for foreigners, imports cheaper → exports fall, imports rise.
- depreciation (falls): exports become cheaper, imports dearer → exports rise, imports fall.
Practice
If a currency appreciates (rises), the country's exports become:
Appreciation makes exports dearer and imports cheaper, so exports fall and imports rise.
Practice
A depreciation makes a country's exports cheaper for foreign buyers.
A weaker currency lowers export prices abroad (and raises import prices at home).
You've got it
Key idea
- the exchange rate = price of one currency in another; floating = set by demand and supply
- appreciation → exports dearer, imports cheaper
- depreciation → exports cheaper, imports dearer