Glossary
Aggregate Demand (AD)
The total demand for all goods and services produced in an economy at a given price level and in a given time period.
Example:
When a country's currency depreciates, its exports become cheaper and imports more expensive, which can lead to an increase in aggregate demand as net exports rise.
Appreciation
When a currency's value increases relative to another currency, meaning it can buy more of the other currency.
Example:
If the US dollar goes from buying 100 Japanese yen to 110 Japanese yen, the dollar has appreciated.
Arbitrage
The practice of exploiting price differences of an asset in different markets to make a risk-free profit.
Example:
A trader might engage in arbitrage by buying gold cheaply in one country and immediately selling it for a higher price in another, profiting from the exchange rate difference.
Consumer Tastes (Exchange Rates)
Changes in consumer preferences for foreign or domestic goods and services, which influence the demand for currencies.
Example:
If American consumers suddenly develop a strong preference for German cars, the increased demand for Euros to buy those cars will affect the exchange rate due to changing consumer tastes.
Depreciation
When a currency's value decreases relative to another currency, meaning it can buy less of the other currency.
Example:
If the British pound goes from buying 1.20 US dollars, the pound has depreciated.
Exchange Rates
The price of one currency in terms of another, indicating how much of one currency is needed to buy a unit of another.
Example:
If 1 US dollar equals 0.92 Euros, that's the exchange rate between the two currencies.
Fixed Exchange Rates
An exchange rate regime where a currency's value is pegged to another currency or a commodity, preventing daily fluctuations.
Example:
Under the fixed exchange rates of the gold standard, the value of the British pound against the US dollar remained constant.
Gold Standard
A monetary system where a country's currency value is directly linked to a fixed quantity of gold, resulting in fixed exchange rates.
Example:
Before the 20th century, many nations operated under the gold standard, meaning their currency could be exchanged for a specific amount of gold.
Net Exports (X-M)
The value of a country's total exports minus the value of its total imports, representing the trade balance.
Example:
If a country exports 400 billion, its net exports are $100 billion, indicating a trade surplus.
Reciprocal Relationship (Exchange Rates)
The principle that if one currency appreciates against another, the other currency must simultaneously depreciate against the first.
Example:
When the US dollar appreciates against the Euro, it automatically means the Euro depreciates against the US dollar; they move in opposite directions.
Relative Income (Exchange Rates)
Differences in income levels between countries, where higher income typically leads to increased demand for imports and thus foreign currency.
Example:
If Canada experiences a significant economic boom and higher relative income compared to the US, Canadians will likely buy more US goods, increasing demand for the US dollar.
Relative Inflation (Exchange Rates)
Differences in inflation rates between countries, where higher inflation in one country makes its goods more expensive and less attractive, affecting currency demand.
Example:
If Mexico experiences much higher relative inflation than the US, American goods become comparatively cheaper for Mexicans, increasing demand for the US dollar.
Speculation (Exchange Rates)
The act of buying or selling currencies based on expectations of future exchange rate movements to make a profit.
Example:
If investors believe the Euro will strengthen against the dollar, they might engage in speculation by buying Euros now, hoping to sell them later at a higher price.