There are a number of different published exchange rates and each has its own significance. Where currencies are fully convertible, foreign exchange markets determine their value. Rates determined by foreign exchange markets are frequently termed market exchange rates. The UK Data Service databanks contain series of market exchange rates; the IMF's International Financial Statistics being the most important of these
Market rates as cross national comparatorsSince the foreign currency is bought and sold using the 'home' or 'local' currency, the exchange rate is the price of that home currency. The rate can be expressed as units of foreign currency for a unit of home currency or units of home currency per unit of foreign currency
e.g. 1.50 euro per pound sterling or 66.66 pence per euro.
In this sense, a currency's market exchange rate is always comparative information.
Published market rates are bi-lateral, between two countries, as in the example above. See following sections for rates relating more than two countries)
The rate indicates the value of traded goods that can bought with a unit of home currency from the other country. It also indicates how currency dealers and their clients rate the two countries. A country judged to be thriving compared to another will tend to attract dealers to its currency hence the rate will rise and vice versa.
Most markets will have forward and other derivative markets in currency, which will differ from spot markets according to the expectations of participants. The IMf publish forward rates in the International Financial Statistics.
Using market rates as cross national comparatorsComparing exchange rates at one point in time has little meaning. The fact that a dollar is worth less than a pound sterling certainly does not reflect anything about the economies of te USA and UK. On the other hand changes in exchange rate are comparable. A rising pound and falling dollar means that the UK are able to buy more goods from the USA than previously; a clear improvement in welfare for the UK.
Exchange rates are not cardinal. You cannot compare values at any one point in time.
You can compare time trends in exchange rates (see later section on indices)
Exchange rates are generated continuously on world currency markets. IMF data published give a number of exchange rates denominated in dollars and SDRs (Special Drawing Rights). There are a number of series, two being based on different time measures, average rate per period, end of period rate.
Compare exchange rates changes using the same currency base and same time period base for each country. Changes in rate can differ depending on which is used.
However there will be many factors influencing a market rate, including the subjective views of dealers as suggested above. Inflation and anticipated inflation, past and possible future productivity, macro and monetary economic policy, political policy and stability, particular very high value international transactions and many other factors determine market rates.
Trade between the two countries may be a very small factor in the international trade of each, making the bilateral rate insignificant as a means of comparison of well-being or competitiveness.
Some countries economies will be more open to trade than others, other countries will be more self-contained and terms of international trade may not affect their welfare much, nor be a good measure of how that country is changing compared to others
The UK Data Service hosts databases containing many 'non-market' exchange rates produced by IGOs and national statistical agencies that ameliorate the above effects and often enable better cross-national comparisons using exchange rates to be made. (See following sections)
Governments often operate in foreign exchange markets or pursue economic policy to attempt to change rates to meet their own objectives. Indeed, from time to time, most governments will try to manage their exchange rates. Frequently a government will 'peg' its rate to another currency, such as the dollar, by operating in the foreign exchange market. Pegged rates reveal more about a country's macro-economic policies than its economic characteristics compared to other countries.
If using market exchange rates for comparison, check each country's exchange rate policy to see if published rates reflect market valuations or macro-economic policy.
A number of countries set their exchange rate by legal means. These exchange rates are called official rates. (See following section)
It can be very misleading to make comparisons between official and market exchange rates
You might want to look at secondary or tertiary rates for such a country.
Often research requires market rates denominated between currencies not used as a base for published rates. For example you may wish to use the rate of exchange between the Myanmar kyat and the Thai baht.
The dollar exchange rates published in the IMF's International Financial Statistics are transitive. Bilateral rates between two countries not involving the dollar can thus be calculated using the dollar rates of the two countries.
