Have you ever heard people say, ‘The dollar has increased, so will the products soon’, and wonder what the dollar has to do with the price of a product?
Well, this is where exchange rates come in.
What is the exchange rate?
Let's first break down what an exchange rate is. The exchange rate is the value of one currency in terms of another one (e.g., 1$=~12,000UZS), meaning how much one unit of currency can buy another currency. It influences international trade, investment, and the economic stability of a country. The stronger the currency is, the more money in another currency it can buy.
Countries adopt various exchange rate regimes based on their economic needs and goals. Today, we will be discussing floated vs fixed types of exchange rates, how they differ, and what kind of benefits they have.
A fixed exchange rate is set up by the government or central banks of a country for a specific period, offering low risks but limited policy freedom.
Floating rates are determined by market forces: supply and demand, offering flexibility and independence to handle economic shocks, but creating higher risks.
Which exchange rate is better?
Fixed exchange rates reduce uncertainty in international trade and help keep inflation under control, but they limit a country’s flexibility during economic crises and require large foreign exchange reserves to maintain stability. In contrast, floating exchange rates adjust automatically to market conditions and act as a shock absorber for the economy, though their constant fluctuations can create higher risks for importers and exporters. Overall, fixed systems offer stability and predictability, while floating systems provide flexibility but introduce greater exchange rate risk.
How do they impact the price of local products, then?
The effect of a rise in the exchange rate is to make imports cheaper, but exporters more expensive, and vice versa.
If imports become cheaper, the cost of raw materials from abroad decreases, thus reducing the cost of production. If imports become expensive, naturally the cost of production increases, thus forcing the business to sell products for higher price in order to meet the cost and keep profit.