How Are Exchange Rates Determined?

Exchange rates are a very important economic phenomena, and they are a reliable sign of an economy’s health. The value of currency relative to other currencies is obviously very important for international business, but it also affects people on an individual level. For instance, if you wanted to send money abroad you would want the best exchange rate possible, to ensure the highest value of the transaction.

There are all sorts of factors that determine exchange rates, such as:

Inflation Rates

Generally speaking, countries with low inflation rates tend to have higher currency value, and this has been true of countries like Switzerland and Japan. Conversely, a high rate of inflation is usually associated with a low currency value, as is the case with Zimbabwe.

Public Debt

Countries with a large public debt are often associated with low currency values. This is what’s happening in certain parts of the Euro-zone, where the value of the Euro is decreasing amidst a difficult economic situation. The reason why public debt leads to lower currency values, is that inflation tends to rise as a result, which discourages investors.

Economic Stability

Related to public debt, countries with unpredictable economic or political situations will put off investors, and this can devalue currency. Quantitative Easing, which is printing money to resolve financial problems, can lead to rising inflation and lower currency value.

Currency rates can change all the time, and the best exchange rates will be determined by long terms and short term factors. Therefore, when sending money to other countries it helps to use a specialist foreign exchange.