Nominal Exchange Rate

The nominal exchange rate is the number of units of the domestic currency that are needed to purchase a unit of a given foreign currency. It can also be seen as the price of an unit of foreign currency, in terms of the local currency.

If we need to give 1.35 dollars to buy one Euro, the exchange rate is 1.35 EURUSD

It's called nominal because it doesn't take the purchasing power into account. The real exchange rate take prices of goods and services into account.

The exchange rate has an influence in the real economy through various channels. It affect exports and imports, prices, capital flows and investment.

Evolution of the EURUSD exchange rate

The nominal exchange rate is a price. It's determined by supply and demand.

When a company imports goods from another country, it's purchasing foreign currency. When a local company exports goods or services to another country, usually it sells the earnings to pay salaries and other expenses in the local country. Imports increase the demand for foreign currency, while exports increase the supply of foreign currency.

When investors decide to purchase stocks, bonds or other financial instruments, they can not only buy local assets, but also foreign assets. When investors buy foreign assets, they are demanding foreign currency. When foreing investors buy local assets, or when local investors bring their money back, they are demanding local currency.

Capital markets play an important role in the exchange rate. Interest rates differentials can be an important factor in the determination of the nominal exchange rate.

Central Banks can play an important role in the nominal exchange rate. Big countries like China, and smaller countries like Argentina, have central banks that intervene directly in the forex market, puchasing and selling foreign exchange . But the European Central Bank and the Federal Reserve also play an important role, by periodically adjunting the interest rate of government bonds.