Exchange rate

An exchange rate is the price of one currency in terms of another currency. A country’s exchange rate influences, and is influenced by, its balance of payments and its performance in the context of domestic macroeconomics. Exchange rate movements also exert a major influence upon activity in the sphere of international economics.

Definitions

A country’s market exchange rate is the rate that is determined by transactions in the foreign exchange market. Transactions in the foreign exchange spot market take effect immediately, whereas transactions in the forward market take effect in three months’ or six months’ time. The ratio of the forward price of a currency to its spot price indicates the market’s expectation of an appreciation or depreciation of that currency.

A country’s effective or trade-weighted exchange rate is the average of its exchange rates with the those of the countries with which it trades - after each has been multiplied by a weight based upon its relative importance in that country’s trade (For example, the weight assigned to the US dollar in calculating its part in the index for the pound sterling depends upon the importance to UK domestic market imports of imports from the USA and the degree of competition between the UK and the USA in the USA market and in third country markets.) Indexes of the effective exchange rates of the pound sterling, the US dollar and the Euro are published are published monthly by the Bank of England. A rise in a country’s effective exchange rate index is generally taken to indicate a corresponding reduction in its international competitiveness. In calculating a country’s real effective exchange rate index the weights assigned to each country are further adjusted to take account of its general price level relative to that of the original country .

A country’s purchasing power parity (PPP) exchange rate is defined as the number of currency units required to buy goods equivalent to what can be bought with one unit of the currency of the base country, usually the US dollar". PPP rates are used in making international comparisons of gross domestic product. A number of international organisations collaborate to provide PPP indexes for member countries using the method of calculation described in an OECD statistics brief , and the resulting indexes are published by the OECD .