Monetary Policy
Currency Swings: What Makes Your Money Worth More or Less?
What It Is and How It Works
When you walk to the kiosk in your neighborhood, you know the shopkeeper will gladly take the same money you get in your paycheck in exchange for the cookies you want. It's the same when you buy clothes at a mall or a concert ticket. When you try to buy something made in another country or travel there, though, things change. Your local money might not be accepted, so you'll have to exchange it for another currency first. The exchange rate, or the price at which one currency can be traded for another, is important because it affects the price of all imports and exports.
The exchange rate is affected by how much people want and need foreign currencies. If the supply of a foreign currency stays the same but demand for it goes up, its price goes up. This makes the local currency lose value. If more people in the U.S. want to buy euros but the supply of euros stays the same, the value of the dollar goes down, which makes it more expensive. If the supply of a currency goes up but the demand stays the same, its value goes down, which makes the local currency worth more.
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The Impact of Exchange Rates
The exchange rate affects two main things in an economy:
Competitiveness: When the local currency depreciates, it makes local products cheaper to foreigners, which can encourage exports. At the same time, it makes imports more expensive, benefiting local industries by reducing competition from foreign goods.
Inflation and Prices: A rising exchange rate makes foreign goods more expensive, which can lead to higher overall prices and affect consumers' purchasing power.
Countries often intervene in the foreign exchange market because the exchange rate is essential. A high exchange rate can make imports more expensive and protect local industries. But, it can also increase inflation, affecting consumers’ buying ability.
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Stakeholders and Political Implications
Exchange rates impact businesses, consumers, and governments. For businesses, especially those that depend on exporting or importing goods, fluctuations in the exchange rate can significantly affect profit margins. Consumers also feel the impact, especially when foreign goods become more expensive due to a depreciating local currency.
Governments use the exchange rate to influence economic conditions. Central banks, for instance, may try to stabilise the exchange rate through direct market intervention. They can also influence currency value by adjusting interest rates or by buying and selling currencies.
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Some Debates Among Economists
Economists often debate the role of central banks in setting the exchange rate. While some believe the exchange rate should be determined purely by the supply and demand market forces, others argue that central banks should intervene to stabilise the currency. There are different systems for managing exchange rates, including floating exchange rates, where the market sets the price, and pegged exchange rates, where governments set fixed or gradually adjusted rates.
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Real World Examples
Brazil's Real Hits Record Low (2024): In December 2024, the Brazilian real hit a record low due to concerns over government spending and economic instability. This depreciation reflected a loss in investor confidence and highlighted the impact of government fiscal policy on currency value.
Argentina Reduces Monthly Crawling Peg (2024): In 2024, Argentina reduced the monthly rate at which its currency, the peso, is devalued. The adjustment was part of the government's strategy to control inflation and stabilise the economy, demonstrating the challenges faced by countries with high inflation rates.