Exchange Rate and Related Topics

Exchange Rate and related topics

Nominal Exchange Rate:

The price at which currencies trade for one another in the market.

Flexible Exchange Rate

A flexible exchange rate is an exchange rate that is determined by demand and supply in the foreign exchange market with no direct intervention by the central bank.

Fixed Exchange Rate

A fixed exchange rate is an exchange rate that is determined by a decision of the government or the central bank and is achieved by central bank intervention in the foreign exchange market to block the unregulated forces of demand and supply.

The concept of Appreciation and Depreciation:

A depreciation (appreciation) of a currency is a decrease (increase) in the value of a currency relative to the currency of another nation.

If the exchange rate rise to 85 from 80 taka per dollar, it means Bangladeshi taka has become weaker as respective to US dollar. That is known depreciation of Bangladesh taka as respect to US dollar.

Alternatively, it can also be interpreted as appreciation of US dollar in respect to Bangladeshi taka. It means US dollar has become stronger in respect to Bangladeshi taka.

In case of depreciation of Bangladeshi taka:

You have to pay more taka for each dollar you exchange. Bangladeshi goods—whose prices remain the same in Bangladeshi taka —will become less expensive to U.S. residents. On the other hand, US goods—whose prices remain the same in US dollar —will become more expensive to Bangladesh residents to import.

Purchasing Power Parity:

A theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries.

Suppose a burger costs 170 taka in Bangladesh and $2 in USA. If the exchange rate is 85 taka per dollar, the two burgers have the same value. You can buy a burger in either Bangladesh or USA for the same price. You can express that price as either 170 taka or $2, but the price is the same in the two currencies. The situation we’ve just described is called purchasing power parity, which means equal value of money.

The world economy operated a fixed exchange rate regime from the end of World War II to the early 1970s. China had a fixed exchange rate until recently. Hong Kong has had a fixed exchange rate for many years and continues with that policy today. Active intervention in the foreign exchange market is required to achieve a fixed exchange rate.