The Exchange Rate:The sixth and final key economic quantity is the exchange rate. The nominal exchange rate is rate at which the monies of several countries can be exchanged one for another. The real exchange rate is rate at which goods and services produced in various countries can be exchanged one for another.
The exchange rate presides over the terms on which international trade and investment occur. When domestic currency is appreciated, it means that its value in terms of other currencies is high. Foreign produced merchandises are relatively low-priced for domestic buyers, but domestic made merchandises are relatively costly for foreigners. In these situations imports are expected to be high. Exports are expected to be low. When the domestic currency is downgraded, case would be opposite. Domestically made goods are economical to foreign buyers. So exports are supposed be high. However domestic customers and investors power to buy foreign made merchandises is bounded. So imports are supposed be low.
Figure: U.S. Real Exchange Rate
Before early 1970’s, the United States exchange rate was fixed in comparison with other key currencies in ‘Bretton Woods System’. The U.S. Treasury stood ready to purchase or trade dollars in exchange for other currencies at preset parities determined by every country's posted assessment of its currency in terms of gold.Since the early 1970’s U.S. exchange rate has been floating free to move up or down in reaction to the market forces of demand and supply (see Figure). When United States interest rates have been comparatively high to other nations as in the early 1980’s the dollar was appreciated. In such a case the dollar would have become much more valuable, as a lot of people have tried to invest in America to capture the high interest rates. We then state that the value of exchange rate is moderately low. The exchange rate is stated as the value (in terms of dollars) of foreign currency. When relative value of the dollar increases, the value in dollars of foreign currency drops. When United nations interest rates dropped relative to those in other countries, the dollar tends to depreciate, to fall in value in order that U.S. goods are economical to purchase and easy to sell. When the dollar’s value is low and dollar has decreased in value, Exchange rate, the value in dollars of foreign currency will be comparatively high.
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