How Does a Country's Foreign Exchange Rates Affect Its Economy?

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The rates at which one nation's currency can be used to purchase another affects all the trade between those two countries by raising or lowering the relative prices of goods traded between them. Exchange rates are particularly monitored for effects on a nation's import and export of goods.

Foreign currency exchange is the result of trading between nations. Since most sellers prefer to be paid in their local currency, an international buyer must buy the seller's currency with his own. When this happens, the price of that currency is set by the ability of the buyer to pay.

The price of an item is typically determined solely by the buyer's willingness to pay and the seller's willingness to sell. The added cost of exchanging one currency for another can increase or decrease the cost of an item. This cost difference can result in an increase or decrease in demand for goods or services produced in another country, because they are cheaper or more expensive than those produced domestically.

When the price of one currency falls, this makes it cheaper to buy goods from that currency's host nation. This in turn stimulates the host nation's economy by causing a surge in demand for its goods and services. However, the lower value of the currency also makes it more expensive to purchase foreign goods for residents of the host nation.

Conversely, when the price of a currency rises, foreign goods become cheaper relative to domestic goods. Domestic production may drop and imports can increase. However, the higher value of the currency makes those foreign-produced goods cheaper.