Have you noticed that your dollar doesn’t go as far when you send money to Europe? Or that it’s going farther than it used to when you send money to India? The definition of exchange rate is the value of one currency compared to another, and global changes can have a big impact on many activities, including international money transfers.
In our guide to exchange rates below, you’ll learn more about how they work, what causes them to change, and how these changes can affect your everyday life.
Key takeaways
- An exchange rate is the value of one currency when compared to another currency.
- Two main types of exchange rates are fixed and floating; the US has a floating exchange rate.
- Factors including supply and demand, inflation, and interest rates all affect the movement of exchange rates.
- Exchange rates can affect the economy you live, spend, and work in, and have an impact on the cost of sending money internationally.
What is an exchange rate?
An exchange rate is how much you’d pay to trade your currency for another. To calculate the exchange rate, multiply it by your current currency to see how much you’ll get.
For example, let’s say the exchange rate for converting US dollars (USD) into Canadian dollars (CAD) is 1.3717. For every $1 USD, you’d get $1.37 CAD (1 x 1.3717 = 1.3717). Exchanging $100 USD? You’d receive $137.17 CAD (100 x 1.3717 = 137.17).
Exchange rates fluctuate all the time due to changes in market conditions, a country’s economy, or government policies. Depending on where you exchange money, you might also pay fees for the transaction.
Fixed vs. Floating: Two types of exchange rates
There are two main types of exchange rates: floating and fixed.
Floating exchange rates depend on the supply and demand of a country’s currency, and “self-correct” based on changes in the economy. The government doesn’t work to keep the exchange rate fixed. With a flexible exchange rate, if the demand for a currency is low, its value will decrease. This makes imported goods more expensive and can stimulate the economy as consumers turn to local goods and services, generating jobs.
Fixed exchange rates are set and maintained by a country’s government, resulting in an official exchange rate. This set price is usually pegged to a major international currency, like the US dollar.
To keep the exchange rate fixed, the central bank buys and sells currency on the foreign exchange market in return for the currency it’s compared against. For example, if a country wants to fix its exchange rate to equal $2 USD, then it must keep enough US dollars in reserve to supply the market. These are called foreign reserves and they help regulate market fluctuations, inflation, and deflation, and as a result, the country’s exchange rate.
| Fixed exchange rate | Floating exchange rate | |
| What determines value | Central bank | Supply and demand |
| Stability | Higher | Lower |
| Monetary policy control | Little or none | High; can adjust interest rates to influence domestic economy |
What causes exchange rates to change?
Five main factors affect how exchange rates work: Supply and demand, inflation, interest rates, political stability, and economic performance. These factors are constantly changing, influencing each other and impacting the value of a currency as compared to another currency. Here’s how each one affects exchange rates.
Supply and demand
Currency values move constantly because they’re traded around the clock. This constant movement changes the supply and demand of a currency, which impacts the rate you can exchange one currency for another.
- Supply is the total amount of a currency that is available to buy.
- Demand refers to how much interest there is among investors, businesses, and the public in buying that currency.
If demand is greater than supply, the price of a currency will go up. If demand is less than supply, the price will go down.
A country’s economic health, growth prospects, and monetary policies affect the supply and demand for its currency. A lot of people from outside a country’s borders investing in local companies or buying goods produced in that country creates more demand. This can put upward pressure on the value of its currency.
Inflation
Inflation, the rate at which goods and services increase in cost over time, can drive interest rates up or down.
Higher inflation tends to weaken a currency’s exchange rate. That’s because it decreases the purchasing power of that currency.
Lower inflation generally pushes a country’s currency exchange rate upward. It means more buying power, more investor confidence, and thus more demand for that currency.
For example, the US economy experienced inflation of 4.2% for the 12 months leading up to May 2026. This caused the US dollar to weaken against some foreign currencies, pushing its rate downward.
Interest rates
Interest rates—the percentage of a loan amount a lender charges for loaning a borrower money—also influence the way exchange rates work.
A country’s central bank sets its benchmark interest rate, which determines borrowing costs for businesses and individuals. This affects how attractive it is to hold that currency for investment purposes.
Lower interest rates boost the economy by making it cheaper for businesses to invest and grow. However, keeping rates too low for too long can lead to high inflation. Because a country’s currency can buy fewer goods and services over time during periods of high inflation, it loses value not only in relation to other currencies but also inside its borders.
Most countries have at least a bit of inflation every year, though central banks will usually try to keep inflation below a certain limit, often around 2%.
If inflation gets too high, central banks will raise interest rates to fight it. A little bit of inflation is often seen as safer for the economy than deflation, where money is worth more and more every year because prices decrease. When deflation happens, people and businesses tend to save money instead of spending and investing it, shrinking the economy.
Political stability
When a country’s government is stable, its policy decisions are predictable and investors feel comfortable holding its currency, helping it maintain its value. Its exchange rate is steady or goes up.
But when a country experiences political unrest, such as contested elections or sudden policy swings, investors can be more skittish about investing, which lowers demand for the currency and can cause its exchange rate to drop.
Economic performance
When a country’s economy is booming, with low unemployment and rising prices, it tends to attract the attention of foreign investors. Demand for the currency rises and the exchange rate goes up.
But if a country is struggling economically or is experiencing a recession, confidence falls, and so does the demand for its currency, pushing the exchange rate down.
How exchange rates impact your money in real life
At the highest level, exchange rates are an indicator of a country’s financial health. A currency’s value usually rises when its country’s economy is strong and falls when the economy weakens. So, basically, exchange rates can be a good gauge of economic standing.
Why else should you keep an eye on a country’s exchange rate? Well, a few reasons. Exchange rates are also important to international trade, foreign investment, travel, and tourism.
International trade
Exchange rates affect the cost of importing goods and the prices businesses get for exporting products, directly impacting profit margins and a country’s competitiveness in international trade. A strong currency makes imports cheaper, reducing costs for businesses that rely on foreign goods and materials. However, it can make a country’s exports more expensive for foreign buyers, which can reduce demand. On the flip side, a weak currency makes it cheaper for businesses and people abroad to buy a country’s goods, which can grow your country’s economy and tax revenue.
Foreign investment
Foreign investors look at things like exchange rates, political stability, and economic growth to inform their decision-making. A strong currency can attract more foreign investment, which can help create jobs, drive economic growth, and lead to more prosperity.
Travel and tourism
Exchange rates are a signal of a currency’s purchasing power abroad—and other currencies’ purchasing power within your borders. Because travelers need to exchange their currency for their destination’s local currency, this has a huge impact on tourism. A weaker currency might attract tourism to your country because it offers travelers more purchasing power. A strong currency might mean your money will go further if you travel to another country, but it also might make domestic travel more expensive.
Sending money internationally
Exchange rates can have a significant impact on people who send money overseas. Even a small shift in the exchange rate could mean a big change to the amount of the remittance. For example, suppose you send $500 to India every month, but the exchange rate goes down. The receiver would get fewer rupees, even though you sent the same amount in USD.
Exchange rate example
Here’s an example of how foreign exchange rates work and how to calculate them. Say you’re sending $1,000 to your family member in Mexico, and the exchange rate is $1 USD to 17.22 MXN. Multiply $1,000 by 17.22 to see that your family member would receive 17,220 MXN.
Three months later, you want to send another $1,000. But there was an unexpected election result in Mexico, which shook investor confidence and drove the exchange rate to 16 pesos per dollar. Now when you send $1,000 USD, your family member will receive 16,000 MXN instead.
Exchanging money: Bid vs. Ask price
Understanding what exchange rates are is one thing; seeing them in action is another.
If you’ve ever tried to exchange two currencies, you may have noticed that the price to sell a currency and the price to buy it are not the same. This difference is called a spread, and it’s how foreign exchange dealers make money.
When you buy a currency, the dealer charges the “ask price.” Think of it as the rate you get when you ask for currency. When you sell currency to the dealer, they charge what’s called a “bid price,” which is essentially their highest bid for the deal. The smaller the spread between ask and bid, the better the deal is for you. The bigger the spread, the more money the dealer collects.
Different dealers set their prices differently, so it’s worth shopping around to find the best rates. For instance, the rates you get at an airport currency exchange kiosk might be a worse deal than the rates you get at a bank. When you exchange currency online with a trusted money transfer service like Western Union, you get transparent exchange rates so you know what to expect upfront.
Send money with confidence
Exchange rates change all the time, so knowing the rate before you send money can help you make smart choices. Western Union’s currency converter lets you see today’s exchange rates and fees for more than 130 currencies around the world, so you can compare services before you send. You can also see live rates and transfer funds quickly when you use the Western Union app to send money.
FAQs
It depends. A higher exchange rate is better if you’re sending money abroad, for example, because your recipient will receive more of their local currency for what you’re sending. A lower exchange rate can be better for domestic businesses if it means their goods are better priced than imports.
In countries where the exchange rate is fixed, it’s determined by that country’s central bank. In countries with a floating exchange rate, it is determined primarily by the foreign exchange market, although monetary policy decisions made by the central banks and policy decisions made by the government can also play a part.
Exchange rates are determined by a wide range of factors, including the supply and demand of a particular currency, and a country’s economic growth, inflation, interest rates, and political stability.
