Understanding Exchange Rates: Key Factors and Implications for Global Trade

Introduction

Exchange rates play a crucial role in the dynamics of global trade, impacting everything from the price of goods and services to international investment strategies. This report aims to elucidate the key factors influencing exchange rates and explore their implications for global trade. By analyzing various determinants such as interest rates, inflation, political stability, and economic performance, the report will provide a comprehensive understanding of how these elements interact to shape currency values. Furthermore, the functional consequences of exchange rate fluctuations on trade balances, competitiveness, and economic growth will be examined.

Main Body

Exchange rates are determined by a multitude of factors that can be categorized into market-driven variables and government policies. One primary market-driven factor is interest rates. Central banks, such as the Federal Reserve in the United States or the European Central Bank in the Eurozone, manipulate interest rates to control inflation and stabilize their economies. Higher interest rates offer lenders in an economy a higher retur