Foreign exchange rates

Introduction

This is the rate that is used to weigh the value of a currency in relation to how much of another currency it can buy or can be exchanged with. Foreign exchange rates of a currency to other international currencies mainly depends on the type of the exchange rate regime that has been adopted in the country and include the following.

Fixed exchange rate 

This is where the government through its policies fixes the rates at a given value and incase it rises or drops, the government interferes to buy international currencies through the central bank.

The main criticisms to this regime are;

o   It doesn’t automatically adjust the balance of trade  thus incase of a trade deficit the demand for foreign currency increases and this will lead to increased price of the foreign currency compared to the domestic currency.

o   The government must have to spend more resources piling up foreign currency so that incase the fixed rate changes they can afford to bring back the rate by buying more foreign currency.

Flexible exchange rates 

This is the regime where the rate of exchange depends on supply and demand .This is the most preferred exchange rate regime as it allows the economy to automatically adjust back to full employment  level with minimum government intervention.

Floating exchange rate 

This is the regime where the domestic currencies value depends on the foreign exchange market, such a currency is called a floating currency.

Linked exchange rate 

This is the regime where the domestic currency is linked with another currency. The government does not interfere with the foreign exchange market under this regime.   

Control of foreign exchange rates

A government may decide to control the rates to ensure that the citizens and other international financial institutions who may be interested in using the domestic currency for either imports or exports abide to the rules set by the government or by the central bank.

The government may decide to control the foreign exchange rates by: 

Practicing fixed exchange rates- By this the government ensures there is minimum contact between the citizens and foreign currencies as it’s the government who interferes directly with the exchange rate and not like that of a flexible exchange rate where the rate depends on demand and supply. 

Controlling amount of currency to be imported or exported- this assures the government that the amount of domestic currency outside the country is not in excess of what is required and that the amount of foreign currency in the country is not excessive thus it can hardly reach out to the general public. 

Restricting citizens from having foreign currencies- this is to ensure minimum access to foreign currencies by the citizens thus they cannot carry out any transaction using foreign currencies in the country. 

Controlling the use of foreign currency within the country-This is done by government policies, rules, and conditions that one must satisfy before handling foreign currencies in the country.

Conclusion

From the above illustrations we  realize that foreign exchange rate depends mostly on governments decisions and the type of exchange rate regime that has been adopted.