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Measuring the value of currencies: Exchange rates and inflation

The FRED graph above shows the exchange rate of two currencies with the US dollar: the Swiss franc and the Colombian peso. We chose these two for their obvious contrasting history.

  • The Swiss franc is considered to be among the strongest currencies—meaning that it tends to appreciate with respect to many other currencies.
  • The Colombian peso is the opposite, with continuing depreciation with respect to strong currencies. (One peculiar benefit of using this currency is that it was never rebased—i.e., never had a few zeroes removed from its high face value. This numeric consistency avoids potential issues with displaying the peso’s exchange rate across various definitions of the currency.)

The graph shows that, over the longer run, the Swiss franc has become stronger than the dollar while the Colombian peso has gotten significantly weaker than the dollar. There are considerable variations at shorter horizons, which can be driven by many factors related to the expectations about the currencies’ respective economies. (This recent FRED Blog post covers this topic.) But back to the long-run changes…

The second graph takes the same exchange rates and adjusts them by the inflation rates in the US, Switzerland, and Colombia. These are so-called real exchange rates. Note how the lines are much flatter, especially as you compare the scale of the vertical axes in both graphs.

A large part of these long-run exchange rate movements can indeed be explained by inflation differentials: Inflation is typically low in Switzerland, while it is typically high in Colombia. The lines are not completely flat, though. First, the consumer price index or the GDP deflator may not be the appropriate price index to use here, as other factors such as taxes, tariffs, and other trade impediments may matter. Finally, most currency exchange is not performed to buy foreign goods, but rather for purely financial transactions. Thus, a currency can be more or less attractive depending on economic or political developments.

How these graphs were created: Search FRED for “Colombia exchange rate” and take the option with the longest time range. Click on “Edit Graph,” open the “Add Line” tab, and search similarly for “Switzerland exchange rate.” Open the “Format” tab and put the legend for the second line on the right. You have the first graph. For the second, take the first graph, click on “Edit Graph,” add series by searching for “US CPI,” then again for “Colombia CPI,” in both cases making sure the series is as long as possible and in levels, not growth rates. Apply formula a*b/c. Repeat for the second line and “Switzerland deflator” (the CPI series is too short).

Suggested by Christian Zimmermann.

Why does women’s employment change with the seasons?

An answer from the NBER

Summer is ending. As the new school year gears up, some areas of economic activity will get seasonal boosts—such as increases in retail sales of office supplies as incoming students and their families buy what they need for the classroom. Female employment also picks up at this time of year. Recent research on labor markets finds that the childcare services provided by formal schooling drive this increase in employment.

The FRED graph above replicates Figure 1 in a related piece of research: the NBER Working Paper, “The Summer Drop in Female Employment,” by Brendan Price and Melanie Wasserman. The graph shows the non-seasonally-adjusted labor force participation rates among males (orange line with triangles) and females (blue line with dots) between 25 and 54 years of age. (The values are normalized to zero in December 2019.*) A close examination of this graph shows that, every summer, women’s labor force participation drops sharply, whereas men’s participation remains comparatively stable.

Why? During the summer, women reduce the amount of time they work outside the home; they are more likely than men to step in and provide some of the childcare services required while school is out for the summer. Vacations, summer school, and camps—supplemented by informal childcare by relatives, for example—do not add up to the six hours per weekday that children spend in school most of the year.

The research by Price and Wasserman helps answer the seasonal puzzle that the FRED Blog described last year, which helps tell the bigger story behind the numbers.

* The data in the NBER paper are two series from the Bureau of Labor Statistics available in FRED through the Organization for Economic Co-operation and Development’s Main Economic Indicators Release. Borrowing from Geoffrey Chaucer: All roads lead the data user to FRED.

How this graph was created: In FRED, search for “Activity Rate: Aged 25-54: Males for the United States.” From the “Edit Graph” panel, use the “Add Line” tab to search for and select “Activity Rate: Aged 25-54: Females for the United States.” Use the “Edit Line 1” tab to customize the units by selecting “Index (Scale value to 100 for chosen date)” and enter “2009-12-01” in the date box. Click on “Copy to all” to apply the unit transformation to both series.

Suggested by Diego Mendez-Carbajo and Mary Clare Peate.

Strong and weak currencies

A primer on exchange rates

It’s common to hear talk of one currency being “stronger” or “weaker” than another. This comparison helps determine how much of each currency is required to make purchases. A currency that’s stronger than another means it requires less of that currency to purchase the same good or service. The opposite is true for weaker currencies.

The graph above compares two currencies with the US dollar (USD) over the past 3 years: the Swiss franc (CHF) and the Canadian dollar (CAD). As we can see, the USD/CHF exchange rate is almost always below 1, while the USD/CAD rate is always above 1 (always above 1.2, in fact). This means, in general, that a Swiss franc is stronger than a US dollar and a Canadian dollar is weaker than a US dollar.

Example: If a cup of coffee in the US costs 3 USD, it would require only 2.61 CHF but 4.02 CAD to purchase that cup of coffee.

Most USD currency exchange rates in FRED appear with the USD as the “base currency” (or numerator in the ratio) and the foreign currency is the “quote currency” (or denominator). This formula answers the following question: For each USD, how much of the foreign currency would it take to achieve the same value? However, there are a few exceptions where the USD is the quote currency—most notably, when comparing it with the British pound sterling (GBP) and the euro (EUR).

The second graph compares the USD with the GBP and EUR. Currently (i.e., at the end of August 2023), the USD is weaker than both those currencies, as the exchange rates are both greater than 1. So, it takes more than 1 USD to match the value of 1 GBP or 1 EUR.

As both graphs show, exchange rates fluctuate daily. There are many factors that can cause an exchange rate to change. One key reason is differences in a country’s inflation rate. Countries with higher inflation tend to have higher interest rates (to help curb inflation) compared with countries with lower inflation rates. For more on these topics, look to these blog posts from Ana Maria Santacreu and YiLi Chien.

Other factors include the amount of public debt. If national debt gets too high relative to national income, it raises the chance a country will create more currency to pay its bills. This can cause a currency to weaken, as the supply of currency increases and/or the demand falls as people sell their own currency for other nations’ currencies.

Finally, overall economic strength plays a role, as countries with robust and stable economies will be more attractive to investors, which increases demand for its currency as more business is conducted within its borders.

How these graphs were created: For the first graph, search FRED for “Swiss Franc to US Dollar” and click on Swiss Francs to US Dollar Spot Exchange Rate. Then click “Add Line” in the “Edit Graph” section, search for “Canadian Dollar to US Dollar Spot Exchange,” and click “Add data series.” Then adjust the time frame to the past 3 years. For the second graph, search for “US Dollars to Euro Spot Exchange Rate” and click on the first option. Then click “Add Line” in the “Edit Graph” section, search for “US Dollars to UK Pound Sterling Spot Exchange Rate,” and click “Add Series.” Then adjust the time frame to the past 3 years.

Suggested by Charles Gascon and Jack Fuller.

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