Exchange Rates
Explain currency exchange, appreciation, depreciation, imports, exports, tourism, and capital flows at an introductory level.
A lesson of Economics, in Global Economics, about 10 minutes.
By the end of this lesson, you will be able to calculate exchange rate conversions, explain the effects of currency appreciation and depreciation, and describe what moves exchange rates.
What Is an Exchange Rate?
An exchange rate is the price of one currency expressed in terms of another.
Example: If 1 USD = 0.92 EUR, then $1 buys €0.92.
Equivalently: 1 EUR = 1/0.92 ≈ 1.087 USD.
Currency Conversion
To convert from currency A to currency B, multiply by the exchange rate.
Example: You have $500 and the rate is 1 USD = 0.92 EUR.
$500 \times 0.92 = €460$
To convert from EUR back to USD: divide by 0.92 (or multiply by 1/0.92):
$€460 \div 0.92 = $500$
Appreciation vs. Depreciation
Appreciation: a currency gains value — it can buy MORE of other currencies.
If 1 USD rises from €0.90 to €0.95 → the dollar has appreciated.
Effect: US exports become MORE expensive for foreigners (they need more of their currency to buy dollars). US imports become CHEAPER for Americans.
Depreciation: a currency loses value — it can buy LESS of other currencies.
If 1 USD falls from €0.90 to €0.80 → the dollar has depreciated.
Effect: US exports become CHEAPER for foreigners. US imports become MORE expensive.
Memory: currency appreciation → exports hurt; imports help.
What Moves Exchange Rates?
Interest rates: higher US interest rates attract foreign capital → more demand for dollars → dollar appreciates.
Inflation: higher US inflation erodes the dollar's purchasing power → dollar depreciates.
Economic growth: strong US growth → foreign investment → dollar appreciates.
Current account (trade balance): large trade deficits → more dollars flowing out → dollar depreciates.
Speculation and expectations: large scale.
Fixed vs. Floating Exchange Rates
Floating: determined by market supply and demand. US, EU, UK, Japan use floating rates.
Fixed (pegged): government sets the rate and intervenes in currency markets to maintain it. China has historically managed its exchange rate (more flexible now).
Currency board/dollarization: a country adopts another country's currency or commits to a fixed rate with full reserves (Panama uses USD; eurozone countries have fixed rates with each other).