Exchange Rates

Abstract

An exchange rate is the relative price of two monies. Exactly what is being exchanged has, of course, varied with the assets that were used as money at any point in time. In ancient times and into the early part of the twentieth century, money generally consisted of a full-bodied metallic coinage of one sort or another. In the past two centuries, it has come increasingly to consist of currency notes and, more importantly, bank deposits. Exchange-rate arrangements have varied from systems in which exchange rates are rigidly fixed to ones in which they could vary freely with market forces. In discussing exchange rates, it is useful to distinguish between nominal and real exchange rates. The nominal exchange rate is simply the actual rate in the foreign exchange market. The real exchange rate, in contrast, is the rate at which a market basket of goods in one country can be exchanged for a market basket of goods in the other. It is, therefore, a theoretical construct rather than something that is directly observable.

The discussion that follows provides a chronological survey of exchange rate behavior, exchange market practices and exchange rate regimes from the classical era forward. It concludes with an overview of the foreign exchange market currently.