Individual Foreign Exchange Markets and the Aggregate Foreign Exchange Market

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We sometimes look at an individual exchange rate (e.g., dollar-euro) by thinking of the market where dollars are exchanged for euros. However, there are many different currencies that are exchanged for the US dollar. There are markets where dollars are exchanged for British pounds, Japanese yen, and so on. We can combine these into an aggregate foreign exchange market. Think of this as being the market where US dollars are bought with and sold for all the other currencies in the world. In this market, there is an aggregate exchange rate, w hich you can think of as an average of the exchange rates in all the individual markets. [***More precisely, you should think of a weighted average. Because the United States trades much more with Canada than with, say, South Africa, movements in the US dollar–Canadian dollar exchange rate matter more than movements in the US dollar–South African rand exchange rate. Chapter 9 "Money: A User’s Guide" has more on exchange rates.***] We show this market in ***Figure 4.15 "Foreign Exchange Market Equilibrium".

　

Figure 4.15 Figure 4.15 Foreign Exchange Market Equilibrium  

Currencies are traded in foreign exchange markets, such as the market shown here in which dollars are bought and sold. 

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