The exchange rate, which can always be found in the corners of the economy pages, can be described as the expression of one country currency in another country’s currency.
So, what is the exchange rate, why is it rising or falling, and what are the reasons for the rise and fall in the exchange rate? We touch on each of these.
Exchange rate is a unit of foreign currency denominated in domestic currency
The expression of one unit of foreign currency in local currency is called exchange rate. For example, if the exchange rate between the US dollar and the Turkish lira is 3, we need to pay 3 Turkish lira to get 1 US dollar. With a different example, if the exchange rate between the British pound and the Euro is 2, we need to pay 2 Euro to get 1 British pound.
Foreign exchange supply and demand is the most important factor determining the exchange rate
Inflation expectations, domestic and international interest rates, factors such as the strength of the national economy determine the exchange rate, but the most important factor is the supply and demand of foreign exchange. Supply and demand of foreign currency may increase or decrease in certain periods. While the increase in foreign exchange supply decreases the exchange rate, the increase in foreign exchange demand raises the exchange rate.
Exchange rate decreases when foreign currency supply increases in a country
For example, when there is an increase in the number of goods and services a country sells to another country, foreign exchange supply increases as there will be foreign exchange inflow to the country. However, foreign currency borrowings also increase the foreign exchange supply. As a result of the increase in foreign exchange supply in a country, the exchange rate decreases and the country’s local currency gains value.
Exchange rate rises when foreign currency demand increases in a country
Demand for foreign exchange increases when we have to pay for goods and services purchased abroad or when we have to pay foreign debts from abroad. Increasing foreign exchange demand in a country causes an increase in the exchange rate and an increase in the exchange rate causes the local currency to depreciate.
Domestic and international interest rates affect exchange rate
Domestic and international interest rates also have a significant effect on the determination of exchange rate. For example, when the domestic interest rates increase, the demand for the Turkish lira increases as the return of the Turkish lira will be higher than that of a foreign currency. This increase causes the Turkish lira to appreciate. The opposite happens when foreign interest rates increase; The exchange rate rises and the Turkish lira depreciates.
Inflation expectations also affect foreign exchange supply and demand
For example, if inflation is expected to rise, demand for Turkish lira will decrease. Decreasing demand also reduces the value of domestic currency. For example, in a country without price stability, the domestic currency tends to lose value. (See also: What is inflation?)
The strength of the national economy affects the exchange rate
A country’s local currency can also gain value according to the strength of its economy. The currencies of countries with healthy economic indicators such as budget deficit, inflation, growth rate and current account deficit are more demanded and this increase in demand increases the value of the currency of that country. The currencies of countries that are not economically strong also often lose value.