AEA: The abbreviation for, the American Economic Association, an organization of over 25,000 professional economists. Founded in 1885, this premier top-of-the-economic-association-list publishes the prestigious American Economic Review, arguably THE number one scholarly U.S. economic journal and the Journal of Economic Literature, arguably THE number one index of economic journal publications. The AEA, as acronymically inclined economists call it, also sponsors an annual conference where professional economists present scholarly papers on their latest scholarly research.
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The price of the currency of one country stated in terms of the currency of another country, that is, the rate of exchange of one currency for another. Exchange rates, also termed foreign exchange rates, are prices determined in foreign exchange markets that are set up to trade the currencies of different nations (foreign exchange). In general, exchange rates reflect the overall health, vitality, and productivity of a nation's economy. However, because exchange rates also affect international trade (exports and imports) among nations they are often subject to governmental policy control. The exchange, also termed foreign exchange rate, is the price of one currency in terms of another. The currencies of different nations are regularly traded for each other over foreign exchange markets. The price established for this exchange of currencies is the exchange rate.
If, for example, someone in the United States is willing to pay two dollars to purchase one British pound, making the price of a British pound $2, then the exchange rate between dollars and pounds is 2 dollars for 1 pound.
These assorted currency exchange rates indicate the relative values of the currencies exchanged. A British pound price of $2, and exchange rate of 2 for 1, generally indicates that the one British pound is twice as valuable as one U.S. dollar. Currency traders give up TWO dollars for ONE pound.
Compare this to the "exchange rate" between a U.S. dime and U.S. nickel. Two nickels can be exchanged for one dime, an exchange rate of 2 nickels per dime, and generating a "price" of 2 nickels. This price clearly indicates that a dime is twice as valuable and can purchase twice as many goods and services, as a nickel. The exchange rate between different national currencies has much the same interpretation.
The Price of TradeCurrencies are exchanged among nations in large part to facilitate the international trading of goods. When the United States buys a truckload of chocolate truffles from England, British pounds are needed to complete this purchase. The U.S. buyer, as such, exchanges U.S. dollars for British pounds.
On the reverse side of international trading, when England buys boatload of barley from the United States, U.S. dollars are needed. The English buyer, as such exchanges British pounds for U.S. dollars.
The resulting exchange rate between U.S. dollars and British pounds thus depends on how much trading transpires between the two countries, which country has the more valuable good, and how much domestic currency is available in each country.
If, for example, the United States has a greater demand for English chocolate truffles than England has for U.S. barley, then the United States will need relatively more British pounds than England will need U.S. dollars. Of course, the resulting price also depends on how many U.S. dollars and British pounds are in circulation. Relatively more money on one side of the exchange means that each unit of that currency is worth relatively less.
Many, Many RatesWith a multitude of countries populated six of the seven continents of the globe (almost 200, none yet in Antarctica), each with its own domestic currency, each trading with currency with other countries, means thousands of different exchange rates.
Not only are U.S. dollars exchanged for British pounds, they are also exchanged for Mexican pesos, Japanese yen, Canadian dollars, and European euros. Moreover, British pounds are also traded form Mexican pesos, Japanese yen, Canadian dollars, and European euros, in addition to U.S. dollars. And Mexican pesos are traded for Japanese yen, Canadian dollars, and European euros as well as U.S. dollars and British pounds. And... the list of possible combinations goes on and on.
The result is a multitude of different exchange rates, or prices of one currency in terms of another. However, these exchange rates tend to be relatively consistent, that is, transitive. If, for example, one British pound can be traded for two U.S. dollars, 20 Mexican pesos, and 250 Japanese yen; then one U.S. dollar can be traded for 10 Mexican pesos and 125 Japanese yen; and one Mexican peso can be traded from 12.5 Japanese yen.
Two Prices in OneEach currency exchange rate is actually two rates or prices. One price for each currency (in terms of the other). A currency exchange rate of two U.S. dollars per British pound indicates that the price of a British pound is two U.S. dollars. However, and inversion of this exchange rate indicates that the price of a U.S. dollar is 0.5 British pounds. An exchange rate of one Mexican peso per 12.5 Japanese yen indicates a Mexican peso price of 12.5 Japanese yen and a Japanese yen price of 0.08 Mexican pesos.
Controlling Rates, Controlling TradeInternational trade necessitates the exchange of currencies. Such trading of goods is one of several factors affecting the exchange rate between currencies. However, the exchange rate between currencies also affects international trade.
Suppose for example the exchange rate between U.S. dollars and British pounds changes from 2 dollars per pound to 3 dollars per pound. That is, the price of a British pound increases. U.S. buyers need to give up more dollars. On the other side of the exchange rate, British buyers of dollars need to given up fewer pounds. The price of a dollar changes from 0.5 pounds to 0.33 pounds.
How might this affect trade between England and the United States?
This clearly suggests that countries can influence international trade by controlling exchange rates. If one country seeks to increase exports to, and decreases imports from another country, then a decrease in its exchange rate would be in order. If the United States wants to encourage exports to England and simultaneously discourage imports from England, it can do so by reducing the exchange rate between pounds and dollars, such as lowering the price of a dollar from 0.5 pounds to 0.33 pounds.
- Higher Price, Fewer Exports: With the higher price of pounds, U.S. buyers are less likely to purchase British pounds and thus the British goods and services purchased with pounds. Exports from England to the United States are likely to decline.
- Lower Price, More Exports: On the other side, the lower price of dollars is bound to encourage British buyers to purchase more U.S. dollars and thus the U.S. goods and services purchased with dollars. Exports from the United States to England are likely to rise.
This particular result can be achieved by increasing the quantity of dollars in circulation. With more dollars in circulation, the price and value of each dollar is less.
Because countries tend to prefer more exports and fewer imports, they generally try to reduce their exchange rate, often by increasing their domestic money supply.
Appreciation and DepreciationRising or falling exchange rates are technically termed appreciation and depreciation.
Note that because exchange rates always come in pairs (dollars per pound versus pounds per dollar), the appreciation of one currency means the depreciation of another currency. If one country implements policies that result in depreciation and a lower exchange rate, more often than not done to increase exports, then another country ends up with appreciation and a higher exchange rate, which results in a decrease in exports.
- Appreciation: A currency is said to appreciate in value if its exchange rate increases, such as an increase in the exchange rate of pounds from 2 dollars per pound to 3 dollars per pound. Currency appreciation makes exports from the country relatively more expensive resulting in fewer exports and usually more imports.
- Depreciation: Alternatively, a currency is said to depreciate in value if its exchange rate decreases, such as a decrease in the exchange rate of dollars from 0.5 pounds per dollar to 0.33 pounds per dollar. Currency depreciation makes exports from the country relatively less expensive resulting in more exports and usually fewer imports.
However, because most countries prefer more exports to fewer exports, depreciation policies of one country are not viewed favorably by its trading partner. The trading partner might even counter with its own currency deprecation policies, policies that might cancel or even surpass that of the first country.
Let the conflict begin!
These countries, and others drawn into the fray, are likely to run rampant with currency depreciation policies, especially domestic money supply increases. Each country trying to out "depreciate" the others. Unfortunately such policies are bound to cause domestic inflation and result in other problems in their domestic economies.
Foreign Exchange Rate PoliciesWith this in mind, let's consider policies designed to control exchange rates, with a keen eye toward international trade, the balance of trade, and the balance of payments. Three particular policy options are worth noting -- flexible exchange rate, fixed exchange rate, and managed flexible exchange rate.
- Flexible Exchange Rate: A flexible exchange rate, also termed floating exchange rate, is an exchange rate determined through the unrestricted interaction of supply and demand in the foreign exchange market. A flexible exchange rate means that a country is NOT trying to manipulate currency prices to achieve some change in the exports or imports. This policy is based on the presumption that the free interplay of market forces is most likely to generate a desireable pattern of international trade.
- Fixed Exchange Rate: A fixed exchange rate is an exchange rate that is established at a specific level and maintained through government actions (usually through monetary policy actions of a central bank). To fix an exchange rate, a government must be willing to buy and sell currency in the foreign exchange market in whatever amounts are necessary to keep the exchange rate fixed. A fixed exchange rate typically disrupts the balance of trade and balance of payments for a country. But in many cases, this is exactly what a country is seeking to do.
- Managed Flexible Exchange Rate: A managed flexible exchange rate, what is also termed a managed float, is an exchange rate that is generally allowed to adjust due to the interaction of supply and demand in the foreign exchange market, but with occasional intervention by government. Most nations of the world currently use a managed flexible exchange rate policy. With this alternative an exchange rate is free to rise and fall, but it is subject to government control if it moves too high or too low. With managed float, the government steps into the foreign exchange market and buys or sells whatever currency is necessary keep the exchange rate within desired limits.
EXCHANGE RATE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 27, 2024].
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