ROLE OF THE EXCHANGE RATE

The exchange rate is a price—the number of units of one nation’s currency that must be surrendered in order to acquire one unit of another nation’s traded in that market, as well as for various composite currencies or constructed monetary units such as the International Monetary Fund’s “SDR,” the European Monetary Union’s “ECU,” and beginning in 1999, the “euro.” There are also various “trade-weighted” or “effective” rates designed to show a currency’s movements against an average of various other currencies.


Quite apart from the spot rates, there are additional exchange rates for other delivery dates, in the forward markets. Accordingly, although we talk about the dollar exchange rate in
currency. There are scores of “exchange rates” for the U.S. dollar. In the spot market, there is an exchange rate for every other national currency the market, and it is useful to do so, there is no single, or unique dollar exchange rate in the market, just as there is no unique dollar interest rate in the market.

A market price is determined by the interaction of buyers and sellers in that market, and a market exchange rate between two currencies is determined by the interaction of the official and private participants in the foreign exchange rate market. For a currency with an exchange rate that is fixed, or set by the monetary authorities, the central bank or another official body is a key participant in the market, standing ready to buy or sell the currency as necessary to maintain the authorized pegged rate or range.

But in the United States, where the authorities do not intervene in the foreign exchange market on a continuous basis to influence the exchange rate, market participation is made up of individuals, non financial firms, banks, official bodies, and other private institutions from all over the world that are buying and selling dollars at that particular time.