| Forex exchange-rate index is designed to measure | | | | media and it squares with the intuitive idea of |
| how, over time, movements in the dollar will affect | | | | appreciation or devaluation of the dollar. When Forex |
| U.S. imports and exports. And to do this well, Forex | | | | exchange as we have defined it goes up (e.g., from |
| index must also take account of any differences | | | | 100 yen to 120 yen), the dollar buys more foreign |
| between the rate of inflation in the United States | | | | currency - the dollar has appreciated. When Forex |
| and the rates of inflation in other countries. Suppose | | | | exchange rate goes down (e.g., from 100 yen to 90 |
| that the rate of inflation were 10 percent a year in | | | | yen), the dollar buys less foreign currency - the dollar |
| the United States but only 3 percent a year in | | | | has depreciated. |
| Germany. The buying power of the dollar in the | | | | Unfortunately, this approach is the inverse of the |
| United States is falling 7 percent a year faster than | | | | concept that international trade economists focus on |
| the buying power of the German mark. | | | | when they describe Forex foreign-exchange markets. |
| Now suppose that Forex exchange rate of the dollar | | | | They define Forex exchange rate in terms of the |
| declined by 7 percent from one year to the next | | | | price of foreign exchange, so the yen to dollar |
| against the mark. Then German buyers would be | | | | exchange rate is the cost of purchasing one yen with |
| getting 7 percent more dollars for their marks; but | | | | dollars. If Forex exchange rate in our terms is equal |
| the decline in the exchange rate would be exactly | | | | to 100 yen to the dollar, the inverse would be $0,01 |
| undone by the greater increase in prices in the United | | | | (one cent) per yen. If the dollar appreciates, from |
| States than in Germany. The number of Mercedes | | | | 100 yen to 120 yen to the dollar (dollar purchases |
| that it took to trade for one Boeing 757 would be | | | | more yen), then Forex exchange rate, expressed as |
| the same in the two years. (At least, this would be | | | | the cost of yen, declines in dollar terms, in this |
| true on average for many goods.) This means that, | | | | example dropping from $0,01 to $0,0083. |
| when a change in Forex exchange rate simply | | | | The appreciating dollar means that yen purchased in |
| compensates for differences in inflation rates, the | | | | foreign exchange Forex markets are now cheaper to |
| relative prices of U.S. imports (from Germany) and | | | | buy with dollars, exactly the concept that trade |
| U.S. exports (to Germany) do not change. | | | | economists wish to show. But it also means that their |
| Readers let us notify: international Forex trade | | | | definition of the Forex dollar-exchange rate falls when |
| economists do it differently. One of the most | | | | the dollar appreciates! This is very confusing and so |
| confusing concepts in economics is the way in which | | | | we define Forex exchange rate as yen per dollar, |
| Forex rate of exchange between two currencies | | | | rather than dollars per yen. |
| should be expressed. As we indicate in the article, we | | | | For those who go on to further studies in |
| choose to express the rate as the number of units | | | | international economics, however you, you will find |
| of foreign currency that can be purchased with one | | | | that the trade economists' definition usually appears in |
| dollar (e.g., let's say the yen is trading at 130 yen to | | | | international Forex articles and journals. |
| the dollar). This approach is commonly used in the | | | | |