# Who sets the course of a currency

## Exchange rate

### What is an exchange rate?

The Exchange rate (also: foreign exchange rate) determines the relationship between two currencies that are set in relation to one another. It regulates the price when changing a foreign currency into a domestic currency or a domestic currency into a foreign currency (nominal Exchange rate) and provides information about the purchasing power and competitiveness (real exchange rate) of a nation.

### Difference between nominal and real exchange rates

For many it stands nominal exchange rate in the centre. It indicates the ratio in which the currency of one country can be exchanged for the currency of another country, e.g. from euros to pounds or from dollars to euros.

The real exchange rate describes the purchasing power of a state. Here the income or the representative basket of goods of two countries is compared.
If, for example, one compares the income of two people from different countries and “only” converts the currency, this is a one-sided view. What is decisive for the person is what they can buy for their money in the country in which they live. If a German earns 2,000 euros and a bread costs 2 euros, for example, he can theoretically buy 1,000 loaves of bread for his earnings. An earner from the neighboring country, e.g. Switzerland, earns e.g. 3,200 Swiss francs and pays 4 francs for a piece of bread. He can only buy 800 loaves of bread a month for his earnings, although he earns the equivalent of more (3,200 francs is just under. 2,800 euros [Aug. 2016]) than the German.

### What causes exchange rate fluctuations?

Exchange rates are determined on the foreign exchange market. They are exposed to regular fluctuations, for example due to differences in supply and demand. The trade in goods controls namely (in addition to the central banks, foreign exchange dealers or political events) the demand for currencies or foreign exchange.

If a country, for example Germany, exports a lot of goods of high value to another country, for example the USA, the demand for euros increases in the USA because the American importers have to pay the invoices of the German suppliers in euros. So you ask for euros on the foreign exchange market in order to settle the bills of the German suppliers. This can trigger an exchange rate fluctuation because the exchange rate for the euro increases as demand has risen accordingly.
If the foreign trade balance of an economy is positive (= it exports higher value than imports), the importers have to buy the exporter's currency. In our example, this leads to an appreciation of the euro.

Enormous fluctuations in the exchange rate of a local currency indicate an economic or financial crisis. The exchange rate therefore plays an important role in the development or economic assessment of a country.