What are currency Exchange rates and monetary policy considerations

Currency exchange rates are a mechanism for determining the relative value of one currency against another. Rates are set by the forces of supply and demand. Market participants negotiate an agreed value at which the exchange takes place. There is no one centralized market place for exchange rates but the majority of transactions occur on the Interbank market between the participants who negotiate the agreed price. Exchange rates are essential for maintaining a workable framework for all matters of international trade and commerce. This article will examine the role of exchange rates and how they can influence economic and planning decisions. Currency exchange rates affect foreign trade. Exchange rates allow countries to determine the relative cost of goods for sale. When one countries exchange rate rises or falls against another, it can create a shift in the way trade and commerce is conducted. Manufacturers and exporters price the cost of their goods in their base unit of currency. If the exchange rate appreciates to a considerable extent then it makes the cost of goods more expensive to the foreign purchaser. This can result in a reallocation of resources as demand for the goods shift to a comparatively cheaper supplier. Central banks are responsible for monetary policy that can influence exchange rates. The economic conditions affecting a country also have an effect on the supply and demand for the currency because they influence current and future expectations. In general, Central Banks are charged with the role of providing price and currency stability. An unstable exchange rate or the presence of inflation can cause a distortion in economic planning that can impact a country adversely. Central banks sometimes intervene in currency markets to enforce their current economic mandates or to protect a currency from excess currency speculation. The Thai government’s role in 2006 is a memorable example of how central bank policy can impact the exchange rate and interconnected equity markets. The danger for a country whose exchange rate appreciates too quickly is that it can harm domestic exports by making them comparatively expensive. Imports, on the other hand, become cheaper. Domestic producers can come under threat if favorable exchange rates allow foreign countries to dump their goods at much cheaper prices, thereby putting domestic producers out of business. A recent example of this is the argument by western governments that the Chinese exchange rate is undervalued relative to the rest of the world. The huge trade surplus amassed by China in recent years is testimony to the effect that a low exchange rate can have on export based industries. Many US based corporations have been put out of business or have had to open manufacturing plants offshore in order to compete. Of course, relative labor rates also play a large part in the pricing differential and planning decisions. The currency markets require careful consideration of the economic variables that affect the country as well as global considerations. In general, currencies tend to trend in the direction of the economic fundamentals. Short term gyrations in money foreign currency exchange rates are also influenced by the conditions affecting worldwide equity markets and decisions by central banks that alter interest rate differentials.