Exchange rate

The exchange rate is the price of a currency expressed in another currency. The market, on the forms of this price, the global foreign exchange market.

The exchange rate is economically very important because it affects the competitiveness of a currency area significantly. For international companies and investors is created by the exchange rate changes exchange rate uncertainty.

• 3.1 On - and write-downs
• 3.2 Mathematical representation
• 3.3 Triggers of exchange rate changes
• 3.4 Effects of exchange rate changes

Types of exchange rates

In general, a distinction exchange rates according to two criteria:

• After inclusion of the price level in the calculation of nominal and real exchange rates can be distinguished.
• After the number of countries against which the exchange rate is calculated, and effective bilateral (multilateral ) exchange rates can be distinguished.

Nominal exchange rate

Basically indicates the nominal exchange rate ratio in which the currency of one country can be exchanged for the currency of another country. The nominal exchange rate can thereby be expressed in quantity or price quotation. The indirect quotation ( "indirect quotation" ) is the price of a unit of domestic currency in units of foreign currency (by the example of Europe and the United States from a European perspective: dollars per euro ). In contrast are the quotation ( "direct quotation" ) the price of a unit of foreign currency in units of domestic currency ( Euro per dollar from a European perspective ). The quotation is thus by definition the inverse of the indirect quotation.

In the euro zone, the UK, Australia and New Zealand, the indirect quotation is used today by the majority, while otherwise the quotation is common, especially in Switzerland. In the euro zone to the euro introduction and the quotation was common.

The exchange rate in indirect quotation is

Calculated in quotation it is

Real exchange rate

The real exchange rate refers to the rate at which a representative market basket of a country against a representative basket of another country can be exchanged. The real exchange rate is thus defined as an index, so its absolute value has no predictive value. Only by looking at the rates of change over time, you can gain important insights. At the rates of change can read the changes in the purchasing power of a country.

A real stronger currency is admittedly characterized by a higher purchasing power vis- out ( also referred to as improved terms of trade ), but simultaneously reduced the competitiveness of the domestic economy.

Bilateral and effective exchange rates

From the bilateral exchange rate is when the exchange rate refers to two currencies. Considering, however, the exchange rate between one currency and a currency basket, then one speaks of the effective (or multilateral ) exchange rate.

The currency basket is composed of the currencies of major trading partners. The effective exchange rate is determined by the average is calculated from all bilateral exchange rates in the currency basket, while each bilateral exchange rate is weighted by the share of each country 's foreign trade. Is weighted by the share of exports, one speaks of the export exchange rate, on the other hand is weighted by the import share, then one speaks of the import exchange rate. Most of the time average of the export and import share is formed, in this case, the effective exchange rate is referred to as external value of the currency.

The effective exchange rate is important because exchange rates from a business perspective are esp. important indicators of their overall competitiveness. However, an exchange rate compare by definition always exactly two economies together. This reduces its explanatory power. To arrive at a more fundamental knowledge of a country's competitiveness, accordingly, there should also for all other exports and imports important exchange rates are taken into account - this makes the effective exchange rate.

The European Central Bank ( ECB) calculated the effective exchange rate of the euro against the currencies of 23 major trading partners ( see the g EER-23 group). Importantly, however, are esp. the U.S. dollar, the British pound and the Japanese yen, which currently account for over 55 per cent share of the total effective exchange rate of the euro. Although currencies do not belong to the EER-23 group, play a relatively minor role, the ECB also determines the effective exchange rate for the 42 most important trading partners, called the EER-42 group.

Exchange rate theories

For a theoretical justification of exchange rate fluctuations, there are several theories that establish a link between the exchange rate on the one hand, and about the price level, the income or the rate of interest at home and abroad on the other side. These theories are typically partialanalytisch, that is they focus on changing one (or less) the exchange rate determining factor.

Basically, one can distinguish between two types of approaches:

• Mundell- Fleming model (absorption approach): Based on a Keynesian theory, this approach depend on the current account balance ( LBS ) of a country, to predict future price movements of the respective currency.
• Interest rate parity approach. " Money goes where the highest returns are to be achieved " Are international capital markets free of capital controls and domestic and foreign financial stocks are perfect substitutes, then it comes through the exploitation of arbitrage opportunities in a perfect conformity of the corresponding rates of return at home and abroad, which arise in part from the direct interest income with respect to the domestic and foreign interest rates and on the other by exchange rate changes. Any deviation of rates of return will lead to capital movements that are focused on the exploitation of profit opportunities and continue as long and lead to adjustments until a new alignment is done.
• Purchasing power parity approach: The purchasing power parity theory derives the exchange rate between two currencies represents the ratio of the respective price levels. It states that exchange rates fluctuate mainly to compensate for differences in price levels between currency areas. Relevant items are baskets that contain only internationally tradable goods. This approach is based on the principle of the "law of one price ". According to the purchasing power parity theory must be a unit of money in all countries have the same purchasing power, so all have the same real value.

• Monetary approach
• Financial market approach (asset approach)
• Macroeconomic portfolio theory

Exchange rate changes

Basically rise to exchange rate changes in supply and demand behavior of market actors. The exchange rate adjusts to where is where supply and demand for a currency. As market players come here (eg central banks of all countries, international banks and companies) as well as retail investors on both major investors.

While the exchange rate changes caused only by supply and demand behavior of private market actors in systems of flexible exchange rates, occurs in systems of fixed exchange rates the central banks as an additional player in the market on the long buys its currency or sold (so-called foreign exchange market intervention ) until the fixed exchange rate is reached.

Exchange rate changes have large macroeconomic importance and therefore play in the context of economic policy a significant role. The examination of changes in exchange rates over time it can be concluded, as the market players to assess the development of an economy.

Since the exchange rate is on a very liquid and often volatile market, exchange rates fluctuate in systems of flexible exchange rates according to experience very strong. The measure of the volatility of exchange rate is referred to as exchange rate volatility. Large exchange rate fluctuations occur mostly on under general financial or economic crises.

And depreciations

Experiences a currency appreciation, if its price rises on the foreign exchange market; there is a devaluation when their price falls in the currency market.

A distinction between nominal and real exchange rate:

• A nominal appreciation or depreciation takes place at every change of the nominal exchange rate.
• A real appreciation or depreciation, however, requires a change in the real exchange rate.

Mathematical representation

Formally, the percentage change in the exchange rate ( WK) calculated as follows:

In a representation of the exchange rate in indirect quotation positive rates of change, however, mean an appreciation of the domestic currency, negative change rate devaluation ( devaluation ). It behaves exactly the opposite, if the exchange rate is presented in quotation, then correspond to positive change rates of devaluation and negative revaluation of the domestic currency.

Example: For an appreciation of the euro against the U.S. dollar, the exchange rate rises in the usual indirect quotation (English indirect quotation ) of 1.25 USD / EUR to 1.50 USD / EUR, then the rate of change is equal to 0.2, this corresponds to an appreciation of twenty percent.

Trigger of exchange rate changes

Are aware of the reasons that make a supply and demand overhang is created, then it is also known as the market actors (or the government at a fixed exchange rate system ) to assess the development of an economy. The main triggers can be:

• Through private market actors triggered changes in exchange rates are often based on changes in the exchange rate expectations (see also derivatives ) due. In this case, investors expect that a currency will revalue and buy this currency in order to benefit from increases in value.
• An increase in the base rate of a country causes an increased demand for government bonds in this country. Since the bonds must be paid in the currency of that country, created an increased demand for this currency, it comes to an appreciation. Accordingly, the currency devalues ​​, if interest rates in the country fall.
• Increased investment interest from foreign investors causes increased demand for domestic currency, there is a revaluation. Accordingly, a waning interest in investment causes a devaluation.
• Exchange rate fluctuations may also be caused by foreign exchange interventions of the central bank (called realignments ). Here, the central bank buys or sells domestic against foreign currency units.

Effect of exchange rate changes

Changes in exchange rates (especially against major trading partners ) are important factors for the overall economic development of a country and often also its trading partners. The effects are very diverse, they only reach their full development over a longer period. The main effects are:

• Residents have to pay more domestic currency as a result of devaluation for the same amount of imported goods. The result is a reduction in import volume and an increase in the demand of residents for domestic goods, to meet the demand of goods, regardless of the exchange rate effect. At the same time foreign importers have to spend less of their currency in order to get the same amount of goods. This leads to an increase in the amount of export. As a result, the current account of the country improved. However, this also leads to a deterioration in the terms of trade, as with the proceeds of a constant amount of exports only a small amount of imported goods can be paid. The resulting positive effect is reflected in the increase in domestic employment.
• The current account effect of the exchange rate may be different in the short run than in the long term; this is referred to in the literature as the " J-curve " effect: Because the bills are predominantly invoiced in the currency of the supplier country, become more expensive ( in terms of domestic currency ) and imports at constant export earnings. This results in a deterioration of the current account. Only when the price lists are updated and run this price change over the respective import and export elasticities for demand response, then increase exports, thus improving the current account.
• Changes in exchange rates have an impact on inflation: A devaluation of the domestic currency directly causes an increase in import prices and thus the consumer price index. This has the consequence that the residents can buy fewer goods ( real disposable income decreases), since they have to spend more money on imported goods. Conversely, an appreciation inflation affects braking, so that real disposable income increases. This effect is short-term.
• Medium represents an appreciation of a loss of competitiveness of domestic enterprises, as the exported goods abroad become more expensive and exports will decline. In contrast, a devaluation has a stimulating effect on the export sector. As part of the balance of payments theory, the effects of exchange rate changes on foreign trade are examined. Important approaches for this purpose are, for example, the Marshall - Lerner condition, the Robinson condition or the J- curve effect.
• Evaluates the currency of a country, so that improved the competitiveness of this country, then this means for other countries that their competitiveness declines. They are referred to economic policy that aims to increase over devaluations of the currency 's competitiveness at the expense of other countries, as competitive devaluation or more generally as beggar-thy- neighbor policies ( in German: 'll kill your neighbor to beggary ).

Exchange rate regime

In principle, the price can either be free form ( flexible exchange rate ) or set by a central bank (fixed exchange rate ). There are also numerous intermediate and special shapes. In general, the exchange rate should be all fixed, the closer two economies are intertwined in the real economy, but only if two economies in a coordinated and coherent monetary and economic policy is conducted.

Flexible exchange rates have the advantages:

• Autonomous monetary policy: the central bank is free to decide in the interest rate policy
• Speculation ( almost) impossible to make
• (theoretically) in the medium term to avoid under - and over-estimates, thus allowing optimal allocation
• Provide stability countries the effects of balance disorders in other countries to limit, such as imported inflation

Disadvantages include:

• High volatility, which could not be justified by many economists view hardly fundamentals
• Transaction costs due to the uncertainty (about currency hedging transactions )

Fixed exchange rates have the advantages:

• No transaction costs in the form of currency hedging transactions
• Apparent safety for investors from abroad
• Calculation security for import and export

Disadvantages include:

• Loss of autonomy in monetary policy: monetary policy of the central bank of the anchor currency is adopted
• Procurement Cost Direct intervention costs (foreign exchange losses) for the purchase and indirect (inflation) on sale of own currency
• Vulnerability to imported inflation