Macroeconomics Assignment Help >> Exchange Rate, Change in Exchange Rate Assignment Help

Exchange Rate

The exchange rate is defined as the price of one unit of currency in term of another currency. If one euro costs 1.5 USD then 1 USD costs 1/1.5=.667 euro. If the exchange rate is stated in term of the euro then euro is called the base currency or the current currency. In most countries, the exchange rate is expressed using foreign currency as the base currency.

Exchange Rate Systems

Different countries have different exchange rate systems. The most important characteristics of an exchange rate system is to what degree the country is trying to control the exchange rate.

1. A country may have completely flexible exchange rate. The exchange rate is then determined solely by demand and supply in free market without intervention of the government or central bank.

2. A country may have completely fixed exchange rate by pegging the exchange rate to another currency or to an average of several currencies.

3. A country may have exchange rate system between these two extremes called “managed floats” In this system the central bank only intervenes under special circumstances when it wants to influence the exchange rate one way or the other.

4. A country also is a part of monetary union where all the countries in union share same currency. There is then no exchange rate between countries in the union.

Change in Exchange Rate

Suppose that the United States is our home country and then the current euro exchange rate in direct notation SD=1.5(euro/USD). In indirect notation SI=0.667(USD/euro)

A foreign currency is more expensive <=> the domestic currency has depreciated

A foreign currency is less expensive <=> domestic currency has appreciated

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