What is a National Currency?
A national currency is a currency issued by the monetary authority or central bank of a country. It is the medium through which the goods or services are purchased/sold within an economy. Currency can be anything that represents value; however, paper notes, coins, and digital cash are the most acceptable modern forms.
Most countries adopt their own national currency, while some countries may use the same currency, such as the euro or dollar. A national currency is designed and manufactured by the country’s government – generally by the central bank.
- The national currency is a government-issued currency that acts as the unit of exchange for goods and services.
- National currencies can be traded in pairs in the foreign exchange market, which is available 24/7 to investors.
- The central banks vary interest rates to stimulate economic growth and control inflation. Both the interest rate and inflation rate drive national currency value.
National Currency and the Exchange Market
National currencies can be traded at a decentralized global market known as foreign exchange (forex) market at exchange rates determined by the forex market. The exchange rate is the price of one country’s currency with respect to another country’s currency; hence, it tells about the economic condition of the country.
The forex market allows 24/7 trading, and currencies are traded in pairs, unlike stocks that can be sold or bought in solitary. It means that if investors sell (buy) one currency in the forex market, they must buy (sell) another currency.
In addition, a weak national currency will benefit exporters, as they will be able to sell more volume of products abroad. Also, it will harm consumers because the imported goods will be more expensive. On the other hand, the exporters will be affected negatively by a strong national currency as they will be able to sell fewer products aboard, whereas the consumers will benefit from the cheaper imports.
Economic Indicators Affecting National Currency
Economic indicators are released as reports, and they show how strong or weak an economy is. It is important to know the health of an economy, as it impacts the value of the currency. The following economic indicators play an important role in determining the national currency value:
1. Interest rates
Generally, interest rates are set by a country’s central bank. In the US, the Federal Reserve Bank is responsible for setting the interest rates, and for the eurozone, interest rates are established by the European Central Bank. The central banks use interest rates to curtail inflation or promote economic growth.
If the central bank increases the rate of interest, individuals and companies must pay more interest on their loans and are left with less money to spare on commercial goods. Hence, the demand for commercial goods decreases, which restrains manufacturers from raising their prices.
Therefore, increasing the interest rate will increase the value of the national currency, decreases the demand for goods or services, and reduces inflation. Similarly, if the central bank decreases the interest rates, people will possess more money, which will increase the demand and production of goods. Hence, a reduction in interest rates will fuel economic growth.
If the interest rate of one country is higher than another country’s interest rate, the money will flow to the former, as investors will earn more interest on their investments. In this case, the exchange in currencies with higher and lower interest rates increases the demand for higher interest rate currency. As a result, the value of a currency with a higher interest rate appreciates, and the one with lower interest rate depreciates.
Inflation refers to the continuous increase in the price of goods or services over a given time. If inflation is too high, it reduces the purchasing power of money. In other words, it reduces the disposable income of people and hurts the economy. Whereas, if inflation is too low, the prices rise too slowly or becomes stagnant. The situation can imply a weak economy.
Central banks will increase interest rates to protect the economy from excessive inflation. It will curb the consumers’ spending capability, decreasing the demand, and prices cannot rise when the demand is lower. Hence, when the inflation rate of a country is higher than expected, investors may invest with an anticipation of an increase in interest rates, thus increasing the national currency value.
However, it depends on the prevailing economic conditions, as excessive inflation may shrink the capital within the economy. In such a case, the value of the national currency may decline. Hence, the central banks try to target an acceptable inflation rate to manage both inflation and growth.
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