An exchange rate “sets the price, in terms of one currency, at which you can purchase another currency.” In summary, an exchange rate means “a way of converting one currency into another” (Baumol and Blinder 378). The US dollar and the euro are the two major currencies in the world. It is crucial to note that both currencies have a floating exchange rate; specifically, exchange rates are determined by the market and therefore determined by the law of supply and demand (379). The demand for the opposite currency is the origin of the exchange rate, and the fluctuation of the exchange rate is the direction in which it goes. The determinants of the exchange rate between the euro and the US dollar are the subject of much debate and many divergent conclusions. The main driving source of the US dollar – euro exchange rate falls largely under the category of international trade. From there, many factors influence the performance of the exchange rate and how it fluctuates, but almost all sources agree on two significant factors: productivity and the real price of oil. Say no to plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get Original EssayDemand in international trade is the primary origin of the exchange rate and the subsequent supply through this trade influences the position of the exchange rate at any given moment. Looking at the question, there are many reasons why a country or group of countries might want to purchase a separate currency. Baumol and Blinder segment these requests into three main categories; in particular, international trade in goods and services, purchases of tangible goods abroad and international trade in financial instruments (380). Baumol and Blinder explain, for example, the demand for euros for the purchase of international goods: “If Jane Doe, an American, wants to buy a new BMW, she will first have to buy euros with which to pay the car dealer in Munich. Therefore, Jane's request for a European car leads to a request for European currency”; summarizing this point, they write: “In general, demand for a country's exports leads to demand for its currency” (380). Baumol and Blinder in explaining the concept of buying physical goods abroad give an example with IBM: “If IBM wants to buy a small Irish computer manufacturer, the owners will undoubtedly want to receive euros. So IBM will have to acquire the European currency first” (380). Overall, they argue that “foreign direct investment leads to demand for a country's currency” (380). Finally, as an example of demand for international trading in financial instruments, Baumol and Blinder illustrate: “If American investors want to buy French stocks, they will first have to acquire the euros that the sellers will insist on for payment. In this way, the demand for European financial assets leads to the demand for European currency… Thus, the demand for a country's financial assets leads to the demand for its currency” (380). As exemplified by Baumol and Blinder, a country's international trade demands are the primary source of the exchange rate. In the supply-demand dichotomy, supply can be found by reversing the above transactions; if a country wishes to sell its goods, physical assets or financial instruments, it must be willing to supply and sell its own currency to facilitate this trade. Baumol and Blinder note that “A country's currency supply comes from its imports and from foreign investments by its own citizens” (380). Beyond these topics, it is necessary to examine the causes that determine exchange rate fluctuations; in short, where is the exchange rate going? One of the most important influenceson the exchange rate between the US dollar and the euro is productivity – as supported by Alquist's statement, “Economy-wide productivity differentials… appear to have a strong impact on the exchange rate.” dollar/euro rate” (5). Productivity differentials are simply the difference between the productivity of two nations or economic groups; in this situation, there is always a certain differential between the productivity found in the European Union and the United States. This is a source for adjusting the exchange rate intuitively between supply and demand. As a group produces more goods for international trade and domestic consumption, the value of the currency needed to purchase those goods increases, as mentioned above in the section on international trade. For example, if the United States shows higher productivity, the demand for US dollars increases. Perhaps the most interesting aspect of this source of the exchange rate is the difficulty in explaining the magnitude of its effect. This differential has a divergent multiplicative effect on exchange rates; as Alquist points out, “an increase of one percentage point in the productivity differential between the United States and the euro area translates into an appreciation of 4.4%” (5). Although Alquist does not lay out a comprehensive model that explains the power of the productivity differential, he states that it can be partially explained by assuming that spending falls disproportionately on national goods (Alquist 18). Clearly, the productivity differential is a noteworthy part of what influences exchange rate behavior. The last major influence on the US dollar-euro exchange rate is the real price of oil. Oil, being arguably the most valuable commodity available, has a major impact on both the United States and the European Union as its price fluctuates. Understandably, the price of oil, as Clostermann and Schnatz describe, “will improve the international competitiveness of those countries that are relatively less dependent on oil imports (or that actually export oil)” (8). As oil prices rise, countries that are more resilient to these price increases – based on their lower dependence – will see smaller economic losses. This will improve the relative position of that country's currency. Clostermann and Schnatz argue that “an increase in the price of oil should therefore result in a real appreciation of the currency of the country least dependent on oil” (8). So, the question to consider is: “Who is less dependent on oil between the United States and the European Union?” Clostermann and Schnatz state: “Although the United States consumes more oil relative to its economic activity than euro area countries, the United States is at the same time more self-sufficient in oil, while euro area countries of the euro depend almost entirely on oil imports. oil to meet their needs. Consequently, a permanent increase in real oil prices in the world should result in a real depreciation of the synthetic euro” (8). This position is somewhat debated, as Alquist argues that oil has no immediate appreciable effect on the exchange rate; However, Clostermann and Schnatz point out that the effects of oil price changes manifest themselves slowly and often lag behind the price change. As such, the change in the exchange rate can be attributed to the change in the price of oil, but Clostermann and Schnatz provide relevant data to suggest that this causality is plausible. “Since oil price changes only slowly lead to adjustments in the real exchange rate, these effects are also felt in subsequent quarters,” they describe.