Exchange Rate and Exchange Rate Policy

Statement

The exchange rate is the price of a domestic currency in terms of a foreign currency.

• Exchange rate policy is the management of the exchange rate by the central bank to achieve macroeconomic objectives.
• An appreciation (under a managed or floating system) or revaluation (under a fixed system) is a rise in the value of the domestic currency against another currency.
• A depreciation (managed or floating) or devaluation (fixed) is a fall in the value of the domestic currency against another currency.

Notes

These terms are examined together because exchange-rate policy is the instrument the central bank moves, and an appreciation or depreciation is the direction of that move. The exchange rate is itself determined in the foreign-exchange market by the demand for and supply of the currency; how a central bank shifts it, and the effects on aggregate demand and short-run aggregate supply, are set out in exchange-rate-centred monetary policy. Whether a depreciation actually improves the balance of trade depends on the Marshall-Lerner condition.