Q:

How does the global economy affect the money exchange rate?

A:

Quick Answer

Changes in the forces of supply and demand in the global economy affect currency exchange rates. Economic forces that impact currency rates also include a country's economic performance, inflation rate predictions, interest rate differentials and capital flows. International currency values influence central banking decisions and can affect domestic monetary policy; for example, a central bank may raise or lower interest rates based on currency levels.

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Full Answer

Currency is a commodity, and currency exchange rates can reveal a country's economic well-being. Different inflation levels throughout the world can affect exchange rates; usually, the lower a country's inflation rate, the higher the value of its currency. Higher-valued currency has more purchasing power and can make an economy stronger; however, it can make that country's industries less competitive. The currency of countries with higher inflation and interest rates tends to be lower than countries with low inflation and interest rates.

Another global economic factor that affects currency rates is a current-account deficit, in which a country spends more than it earns in foreign trade. A country in a current-account deficit must borrow from other countries to make up the difference. High demand for foreign currency causes a country's exchange-rate to drop. A country with increased terms of trade, or higher demand for its exports, raises demand for that country's currency. This higher demand leads to higher currency values.

Countries that do not face major stability problems, such as war, disease or corruption, tend to be favored by foreign investors. Relative political and economic stability in the global market benefits a country's currency value. Stable countries attract more foreign direct investment. They are more likely to be desired by foreign investors, who directly invest in existing companies or build new companies overseas.

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