currency exchange rate
currency exchange rate
What is the exchange rate and what factors affect it?
What is an exchange or currency conversion?
Ever since mankind stepped beyond the borders of his country and began to exchange, a concept called currency was born. Currency, which means foreign money, must be exchanged with a certain coefficient compared to the national currency. This coefficient is known as exchange rate. Perhaps at first glance, this issue is only important for economists or big economic activists; But the exchange rate is important for all people who travel, shop online or even live in an economy dependent on foreign currencies.
What is the exchange rate?
Exchange Rate is the exchange rate of two currency units between two different countries. In other words, for paying one unit of the currency of one country, how much money of another country can be obtained. In simpler language, if someone gives one rial, how many dollars will he receive. For this reason, this concept is called exchange rate, because it is between two countries, and in economic literature, foreign money is called currency. Let’s take a real example.
We are all now aware of the price of the dollar in the Iranian market compared to the rial. The rate at which the rial and the dollar are exchanged is called the exchange rate or exchange rate. If we base it on the spot price of Tether traded in exchanges, at the moment (mid-May 1402), one can get 0.0000017 dollars for paying each Iranian rial. This rate is not tangible for us, because we always calculated the dollar to rial rate; Therefore, the exchange rate of the dollar against the rial is 562,820. In the following, we have shown the parity rate of different and common currencies of the world in the form of a table
| Exchange rate | currency pairs |
|---|---|
| 0.9 | (USD/EUR) |
| 0.7 | (USD/GBP) |
| 136.7 | (USD/JPY) |
What are the consequences of changing the exchange rate and why is it important?
Addressing the issue of exchange rate parity is important because it deals with the external sector of the economy. In other words, when the exchange rate is discussed, the activity in the geographical territory of an economy no longer makes sense, and the competitiveness of that economy in the international space is taken into consideration. Of course, as much as the exchange rate is important in the international arena, it can have significant effects on the domestic economy. In the following, we describe the cases that can be affected by the exchange rate change.
Export and import (trade balance)
Changing the exchange rate has a direct impact on foreign trade. When the exchange rate increases, exports become more justified; Because more currency is obtained for each export unit. On the other hand, imports will cost more; Therefore, with an increase in the exchange rate, exports increase and imports decrease. The reverse of this case is also true. A change in the exchange rate, followed by a change in the trade balance, can affect production, prices and, of course, employment. How? When the desire to export increases, there is a possibility of a shortage in the supply of goods and services inside the country. The first effect that the lack of goods and services has on the market is the increase in prices. There is another mode. Raw materials or intermediate goods may be supplied through imports, in this case the final cost of production (the cost of making each unit of goods or services) will be higher than before and the producer will supply the goods more expensively.
Another significant issue that exists regarding exchange rate parity and export and import is the issue of dumping. Dumping is the sale of goods and services at a lower price than the world market price. There are different ways to implement dumping, one of which is to keep the exchange rate of the country of origin low.
Tourism
When you want to choose a travel destination, one of the parameters you pay attention to is the exchange rate of the destination country. The higher the exchange rate, the higher your travel expenses and vice versa; Therefore, changing the currency value of countries can affect their tourism industry. Of course, note that besides the exchange rate, other factors such as security and such factors have an effect on attracting tourists.
investment
The investor seeks to get the highest possible income from his investment. On the other hand, there is a term in the financial market called “capital is timid” which states that capital runs away from uncertainty and unstable conditions. The investor wants to be sure that in return for his investment, firstly, his capital is safe, secondly, a planned profit can be obtained. The change in the exchange rate makes the domestic investor face a challenge because he cannot plan. An increase in the exchange rate in a country is unfavorable for the domestic investor, but it provides a good opportunity for the foreign investor.
Types of exchange rates or exchange rate regimes
What we mean by the types of exchange rate parity is the ways in which the exchange rate is established in an economy and what attitude the relevant institution, which is the central bank, has towards it. In general, the exchange rate has two modes; One is a fixed or so-called pegged exchange rate and the other is a floating exchange rate. Of course, there are other modes, such as managed or crawling exchange rates, which are between the two general modes or their subsets. The determination of the currency system depends on the degree of freedom and openness, the inflation rate, the development of financial markets and, in general, the monetary policy of each economy. In the following, we will explain about the types of currency systems.
Floating Exchange Rate System
In the floating exchange rate system, which is also called flexible, only market factors (supply and demand) are involved in determining the rate, and the government or the relevant institution such as the central bank does not play any role in its formation; Of course, they may influence it by changing monetary policies or using monetary tools such as Open Market Operation. Having a floating exchange rate regime has several advantages. Choosing this type of currency system gives the government more flexibility in its monetary policy. When the government is not dependent on a fixed exchange rate, it can use monetary policy to achieve other goals, such as stimulating economic growth or controlling inflation.
Another thing that comes to mind is that a floating exchange rate can help protect the domestic economy from global shocks. When the value of the currency changes, it can have a big impact on import and export prices. A floating exchange rate can help facilitate these changes.
Of course, we should not forget that the floating exchange rate regime also has disadvantages. For example, there will be a possibility of extreme fluctuations. This will make it difficult for businesses to plan and can also make it more difficult for consumers to make purchases in foreign currencies.
Another thing is that the floating exchange rate can make it more difficult for the government to manage inflation. As we mentioned above, the change in the exchange rate can affect the price of goods and services. Of course, we should keep in mind that if the whole economy works properly, if the prices, i.e. the place where supply and demand meet, are out of balance, they will return to their optimal state with a break and appropriate policies.
fixed or pegged (Fixed Exchange rate)
A fixed exchange rate regime, also known as a pegged rate, is a type of model for determining the exchange rate in which the value of a country’s currency relative to the currencies of other countries is determined by a monetary authority.
In this case, the central bank, which is the most recognized monetary authority of any country, must keep a large amount of currency or anything else that the national currency is considered stable in relation to, so that it can intervene in the market if needed and the ratio and price keep constant. The same issue closes the hands of the central bank to implement monetary policies, because it may have to sacrifice other goals and policies to maintain balance.
If we want to talk about the advantage of this type of currency system, we can point out that stability and predictability are available for businesses and investors in this case, because they can plan and make decisions more confidently about the future value of the currency and its related matters. .
Managed (Managed Exchange rate):
The managed currency system is a type of intermediate currency system in which the exchange rate is considered neither fixed nor floating; Rather, it is managed by the central bank or the government in order to achieve certain economic goals. In this case, the relevant institution intervenes to influence and determine the price in the currency market. This can be done to achieve goals such as maintaining price stability, promoting exports, or reducing exchange rate fluctuations.
One of the advantages of the managed exchange rate system is increasing stability and predictability for economic operators. At the same time, this method can be subjected to political pressure and vulnerable to speculation and market fluctuations.
Factors affecting the exchange rate
Several factors can affect the exchange rate. These factors can be divided according to their nature. For example, two economic and political categories can be considered for them. First, we mention the economic factors affecting the exchange rate.
swelling
As we know, inflation means an increase in the general level of prices and a decrease in people’s purchasing power. In this situation, the value of the national currency decreases. In inflationary conditions, the purchase of domestic and foreign goods and services becomes more expensive for people. Because the demand for foreign goods and services decreases, the demand for the currency of the foreign country also decreases and this issue creates downward pressure on that currency. The reverse of this case is also true. Of course, we should not forget that various factors affect the exchange rate and cause its formation; So, if you are thinking about why the issue of Rial and Dollar is not like this, we should keep in mind that it is not only the inflation rate that is decisive.
Interest rate
Interest rate is the price of money. When the interest rate in one country is higher than another country, investors tend to transfer their money to a country with a higher interest rate; Because in this case, a higher return will be given to their capital. This issue increases the value of the country’s currency that has a higher interest rate.
Economic Growth
Economic growth generally indicates the improvement of conditions. When there is growth, the size of the economy becomes larger, and in this situation, businesses and individuals create more income and are likely to earn more. When income increases, consumption and savings also increase. When the economic growth rate of the first country is higher than that of the second country, the domestic and international demand for its goods and services increases and this leads to an increase in the demand for the currency of that country.
Trade balance
When an economy opens its doors to the global economy, it should also play a role in exports and imports. Trade balance shows the performance of an economy in the foreign sector. If the trade balance is positive, it means that the export amount is more than the import amount. The reverse of this case is also true. If the trade balance is positive, the currency inflow is more than its output, or in other words, the supply will be more than the demand; Therefore, the domestic currency becomes stronger than the foreign currency. In general, the more an economy depends on imports, the higher the demand for currency in that country.
Speculation
Speculation is a very familiar word for us Iranians. This word means buying and selling an asset in order to gain profit from its price change. When some people predict that the price of a currency will increase in the future, they buy it. There is also the opposite of this case. This behavior affects the currency price in the short term. If there are suitable markets such as derivatives or futures market with the necessary infrastructure, the effect of these behaviors will be less.
The government or governments (States), as an institution that provides the necessary platforms for economic activities, can direct it with their policies. Sometimes it is possible that the central bank, as the main custodian institution, intervenes in its market according to the currency system (fixed, floating, etc.). This can be implemented through buying and selling currency, subsidies to exporters and other methods. Another thing that can be mentioned in the field of political factors affecting the exchange rate is the currency war. In order to achieve their goals, countries and politicians deliberately adopt policies that make their country’s exchange rate go down. The explanation about the currency war is very detailed and interesting.
