Exchange rates and the balance of payments
An exchange rate is the price of one currency in another, and it decides what a company's foreign sales are worth at home. This lesson shows how to read a rate in both directions, what links it to interest rates and prices, and how the balance of payments records a country's dealings with the world. A calculator splits a US company's reported growth into business growth and currency effect. It ends with Coca-Cola and McDonald's, whose 2025 results were pushed in opposite directions by currencies.
- Level
- Beginner
- Reading time
- About 28 minutes
- Know this first
- Yield curves
By the end you will be able to:
- read an exchange rate in both directions and calculate its percentage change
- explain how interest rates and exchange rates are linked, and apply covered interest parity
- name the parts of the balance of payments and read a current-account deficit
- separate a company's growth from the effect of currency
- explain why the same exchange rate move can help one company and hurt another
The price of one currency in another
Every lesson in this module has been about one economy. But most economies trade with others, and each country has its own money. An exchange rate is the bridge: the number of units of one currency you get for another. This lesson covers what an exchange rate is, what moves it, how a country's dealings with the rest of the world are recorded, and how a swing in a currency shows up in a company's reported results.
The last point is where finance cares most. A US company with sales in Europe reports in dollars, so every euro it earns has to be translated. If the euro rises, those sales are worth more dollars, even if no extra product was sold. The lesson ends with two of the world's best-known companies, Coca-Cola and McDonald's, whose 2025 results were pushed in opposite directions by currencies.
Reading an exchange rate
The European Central Bank (ECB) explains an exchange rate as how much of one currency you get for another, and gives the example of €1 for $1.13. The rate changes constantly on global markets where currencies are traded, and the euro, US dollar, Japanese yen and pound sterling are among the most traded. The ECB also publishes daily reference rates, which are averages of buying and selling rates, and notes that they are often used in financial statements, tax returns and economic analysis.
A rate can be written two ways, and mixing them up is the most common error. "Dollars per euro" of 1.17 means one euro costs $1.17. The same fact written the other way, "euros per dollar", is 1 ÷ 1.17 = 0.85. When dollars per euro rises, the euro has appreciated and the dollar has depreciated. The table uses the Federal Reserve's series, dollars per euro, as the average for selected months, with the inverse beside it.
| Month | Average, dollars per euro | Euros per dollar | Change in dollars per euro |
|---|---|---|---|
| December 2021 | 1.1301 | 0.8849 | – |
| September 2022 | 0.9899 | 1.0102 | −12.4% |
| December 2022 | 1.0591 | 0.9442 | +7.0% |
| December 2023 | 1.0909 | 0.9167 | +3.0% |
| December 2024 | 1.0472 | 0.9549 | −4.0% |
| June 2025 | 1.1534 | 0.8670 | +10.1% |
| December 2025 | 1.1710 | 0.8540 | +1.5% |
| June 2026 | 1.1516 | 0.8684 | −1.7% |
| September 2026 | 1.1505 | 0.8692 | −0.1% |
In December 2021 one euro averaged 1.1301 dollars. By September 2022 the monthly average was 0.9899, below one dollar for the first time in this table. From December 2024 to December 2025 the monthly average rose 11.82%, from 1.0472 to 1.1710 dollars, and the September 2026 average was 1.1505. Look at what that 2025 move looks like from the other side. The dollar's price in euros fell from 0.9549 to 0.8540, a drop of 10.57%. The two percentages are not equal, because they are measured against different starting points. Always say which currency is being measured.
What moves an exchange rate
Nobody has a complete answer, and the sources used here do not list the causes. Two links are well documented. The first runs from interest rates to the exchange rate. The Federal Reserve says that a change in its policy rate also affects the dollar's exchange rate, alongside share prices, house prices and credit conditions. A higher return on dollar deposits and bonds can attract money into dollars. The second runs the other way: from the exchange rate to prices. The ECB explains that when the euro appreciates, US products become cheaper in the euro area, import prices fall, and euro area inflation is affected both directly, through imported goods, and indirectly, through imported materials. It adds that it does not try to influence the exchange rate with its monetary policy, though it watches it when judging inflation.
One piece of theory ties interest rates to exchange rates exactly. If investors can lock in a future exchange rate today, called a forward rate, they should earn the same on a safe loan in either currency. Otherwise they could borrow in one currency, lend in the other and make a profit with no risk. That requires the forward rate to differ from today's rate by the difference in interest rates, a result known as covered interest parity.
Take the Fed's target range midpoint of 3.875% and the ECB deposit rate of 2.50% from the central banks lesson, as stand-ins for short-term rates, and the September 2026 average rate of 1.1505 dollars per euro as a stand-in for the spot rate. Parity implies a one-year forward rate of 1.1659, which is 1.34% above the spot rate. The higher-rate currency, the dollar, is the one that is cheaper forward: a euro buys more dollars in a year's time. This is a calculation from the formula, not an observed price, and real forward quotes also reflect trading costs.
The balance of payments
A country's balance of payments is the record of its transactions with the rest of the world. The US Bureau of Economic Analysis (BEA) reports it quarterly. It has three main parts. The current account covers trade in goods and services, income earned on investments across borders (primary income), and transfers such as gifts and aid (secondary income). The capital account covers small capital transfers. The financial account covers purchases and sales of assets across borders: shares, bonds, loans and property.
A deficit in the current account means the country paid out more to the rest of the world than it received. The money has to come from somewhere, so in principle the financial account shows the matching inflow, which is foreigners buying US assets or lending to US residents. The BEA's release for the second quarter of 2026, published on 24 September 2026, reports a current-account deficit of $246.0 billion. Exports of goods and services, plus income, were $1.44 trillion and imports $1.69 trillion, and the gap between those rounded totals is about the same $250 billion. The net financial-account transactions were −$369.7 billion, which the BEA says reflects net US borrowing from foreign residents. The components that make up a current account are clearer in the first quarter, whose revised figures are below.
| First quarter 2026 (revised), $ billions | |
|---|---|
| Goods | −250.9 |
| Services | +92.1 |
| Primary income | −15.8 |
| Secondary income | −38.0 |
| Current account | −212.6 |
The goods deficit of $250.9 billion is far larger than the whole current-account deficit of $212.6 billion, because the United States earned a surplus of $92.1 billion on services. Primary income, the return on foreign investments net of what the US pays foreigners, was a small deficit. The balance accumulates. The BEA reports the net international investment position, the value of what US residents own abroad less what foreigners own in the US, at −$22.42 trillion at the end of the second quarter of 2026: assets of $46.97 trillion against liabilities of $69.39 trillion. In principle the current and financial accounts mirror each other. In practice they differ because of measurement error, and the release text read here does not reconcile the two second-quarter figures.
When the currency moves a company’s results
This calculator is a stylised US company with sales in the euro area. Last year it sold €1,000 million, spent €800 million, and earned €200 million at an exchange rate of $1.0472 per euro, the December 2024 value in the table. Set the exchange rate this year, how fast its euro sales grow, and what share of its costs it pays in dollars, for instance because it makes the goods in the United States. The calculator shows what it reports in dollars, and splits growth into the part from the business and the part from the currency. Amounts are in millions of dollars. It starts with the December 2025 rate of about $1.17 and euro sales growth of 3%.
With the euro at $1.17, euro sales growth of +3% and 0% of costs paid in dollars, revenue reported in dollars changes by +15.08%: +3.00% from growth in euros and +12.08 points from the exchange rate. Profit changes by +15.08%, with +12.08 points from the exchange rate.
Four experiments. First, leave the starting settings alone. The euro's monthly average rose 11.82% against the dollar and euro sales grew 3%. Reported revenue rises 15.08%, of which 3 points come from growth in euros and 12.08 points from the exchange rate, which needed no extra sales at all. Profit moves by the same percentage, because the costs are also in euros. Second, set the euro growth to 0% and the share of costs paid in dollars to 100%. Revenue still rises 11.73%, but profit rises 58.63%. The company earns in euros that are worth more and pays costs in dollars that have not changed, so the whole currency gain lands on a much smaller profit base. This is the same effect as in the operating leverage lesson, with the costs fixed in a different currency. Third, set the exchange rate to $0.95, growth to −5% and the share of costs paid in dollars to 50%. Revenue falls 13.82% and profit falls 31.45%, with 26.45 points of the profit fall from the currency. Fourth, set the rate to $1.05, about last year’s level, with growth 0% and costs 0% in dollars. Revenue and profit change by only 0.27%, which shows that the currency effect is the difference between two exchange rates, not the level of one.
Two companies, one year, opposite currency effects
Coca-Cola and McDonald’s both sell around the world and both report in dollars. Both also split growth into a currency part and a part that leaves currency out. Their 2025 results moved in opposite directions. Coca-Cola reported net revenues up 2% for the full year, made up of organic growth of 5%, a 1-point reduction from acquisitions, divestitures and structural changes, and a 2-point reduction from currency. McDonald’s reported consolidated revenues up 4%, or 2% in constant currencies.
| 2025 against 2024 | Coca-Cola | McDonald’s |
|---|---|---|
| Revenue growth, reported | +2% (net operating revenues) | +4% (consolidated revenues) |
| Revenue growth leaving out currency | +5% organic, after a −1 point structural effect | +2% in constant currencies |
| Currency effect on revenue growth | −2 points, stated | About +2 points, from the gap (4% less 2%, rounded figures) |
| Operating income and currency | +13% comparable currency neutral; currency −7 points | +6% reported, +4% in constant currencies |
For Coca-Cola, currency was a headwind: it took 2 points off revenue growth and 7 points off comparable operating income growth, which grew 13% on a currency neutral basis. For McDonald’s, the gap between reported and constant-currency figures implies a tailwind of about 2 points on revenue, which is a calculation from rounded numbers and not a figure the company states. The euro rose 11.82% against the dollar over 2025, which would raise the dollar value of euro earnings, and that fits McDonald’s result. Coca-Cola’s decline means that, on balance, the currencies it earns in lost value against the dollar. The releases read for this lesson do not give a currency-by-currency account, so which currencies drove each result is not shown here. The company mix matters: the same exchange rate cannot be good for one global company and bad for another unless their currencies differ.
Coca-Cola also says how much the future might matter. For 2026, it expects an approximate 1% currency tailwind on comparable net revenues and an approximate 3% tailwind on comparable earnings per share growth, based on current rates and hedged positions. The sign has flipped from 2025, with no change in the business. That is why analysts quote growth both ways, and why a company’s reported figures need the currency effect taken out before judging how well the business did.
What this lesson leaves out
- One pair of currencies. The euro and dollar are the two most traded. Many currencies are managed or pegged, which this lesson does not cover.
- The causes are not settled. Only the two links described by the Fed and the ECB are covered, and parity is a theoretical relationship, not an observed price.
- The company in the calculator is invented. It is a simple setup with euro sales and two kinds of costs. Real companies hedge, price in several currencies and have many more exposures.
- Translation is only one effect. The calculator shows the translation of foreign results into dollars. Currency also changes the price at which a company can sell abroad, which this lesson does not model.
- Balance of payments figures are revised. The BEA revised the first quarter by about $14 billion in this release, and the second quarter will be revised too.
- Two companies, one year. They illustrate opposite effects and are not a sample.
Common mistakes
Mixing up which currency the rate is quoted in
Dollars per euro and euros per dollar are inverses. Rising in one means falling in the other.
Assuming the percentage changes match
A euro that rises 11.8% against the dollar means the dollar fell by a smaller percentage, about 10.6%, measured in euros.
Reading a current-account deficit as a loss
It means a country paid out more to the world than it took in, and financed the gap by borrowing or selling assets. Whether that is a problem depends on what the money was used for.
Treating currency-driven growth as business growth
Revenue can rise purely because a foreign currency strengthened. Companies report the figure both ways for that reason.
Assuming a strong currency is good for every company
It raises the dollar value of foreign earnings but makes exports dearer. The effect depends on where a firm earns and spends.
Try it yourself
1. The euro averaged $1.0472 in December 2024 and $1.1710 in December 2025. What was the percentage change in dollars per euro?
Show the working
1.1710 ÷ 1.0472 − 1 = 11.82%. The euro appreciated against the dollar.
2. Express the same two rates as euros per dollar, and find the percentage change.
Show the working
1 ÷ 1.0472 = 0.9549 and 1 ÷ 1.1710 = 0.8540. The change is 0.8540 ÷ 0.9549 − 1 = −10.57%, a different size from the rise in the euro, because the starting point is different.
3. The spot rate is $1.1505 per euro, the dollar interest rate is 3.875% and the euro rate is 2.50%. What one-year forward rate does covered interest parity imply?
Show the working
1.1505 × 1.03875 ÷ 1.025 = 1.1659, which is 1.34% above the spot rate.
4. In the first quarter of 2026 the revised balances were goods −250.9, services 92.1, primary income −15.8 and secondary income −38.0 (billions of dollars). What was the current account?
Show the working
−250.9 + 92.1 − 15.8 − 38.0 = −212.6, a deficit of $212.6 billion.
5. Coca-Cola’s 2025 organic revenue growth was 5%, structural changes took off 1 point and currency took off 2 points. What was reported growth?
Show the working
5 − 1 − 2 = 2%, which matches the 2% net revenue growth it reported.
Where this is used
- A multinational company reports growth with and without currency, so readers can see how the business did.
- An importer or exporter checks how a move in the exchange rate changes what it pays or earns, and decides how much to hedge.
- An investor in foreign shares or bonds earns the asset’s return plus or minus the currency’s move.
- A central bank watches the exchange rate for its effect on import prices and inflation.
- A traveller or a family sending money across borders feels the rate directly in what a payment is worth.
Key terms
- Exchange rate
- The amount of one currency that buys one unit of another.
- Appreciation and depreciation
- A currency rising or falling in value against another.
- Forward rate
- An exchange rate agreed today for a deal at a set date in the future.
- Covered interest parity
- The link between the spot rate, the forward rate and the interest rates of two currencies.
- Balance of payments
- The record of a country’s transactions with the rest of the world.
- Current account
- Trade in goods and services, income from abroad, and transfers.
- Financial account
- Purchases and sales of assets across borders.
- Net international investment position
- What a country’s residents own abroad less what foreigners own in the country.
- Constant currency
- A result calculated as if exchange rates had not changed.
- Organic growth
- Growth leaving out currency and the effect of buying or selling businesses.
Questions people ask
Is a strong currency good or bad?
Neither in general. It makes imports cheaper and foreign earnings worth less at home. Who gains depends on where each person or company earns and spends.
Why do companies report constant-currency growth?
Because exchange rates move for reasons that have nothing to do with how well a business sold. Showing growth both ways separates the two.
Does a current-account deficit mean a country is in trouble?
Not by itself. It means the country borrowed or sold assets to fund the gap. What matters is what the money was used for and whether lenders keep lending.
Does the ECB try to set the euro’s exchange rate?
No. In its own explainer, the ECB says the exchange rate is not a policy target and that it does not try to influence it with monetary policy operations, though it watches it for the effect on inflation.
Sources and review
- Board of Governors of the Federal Reserve System, US dollars to euro spot exchange rate (EXUSEU), US dollars to one euro, monthly, as published by the Federal Reserve Bank of St. Louis (last updated 1 October 2026), for the rates in the exchange-rate table.
- European Central Bank, What is the role of exchange rates? (explainer), for the definition of an exchange rate, the effect of the euro’s value on import prices and inflation, and the ECB’s stance on the exchange rate.
- Board of Governors of the Federal Reserve System, Monetary policy: what are its goals? How does it work? (page last updated 29 July 2021), for the Fed’s goals, the 2 percent PCE objective, its tools and the way a rate change spreads.
- Board of Governors of the Federal Reserve System, Federal Reserve issues FOMC statement (16 September 2026), for the decision, the vote and the description of inflation and activity.
- European Central Bank, Key ECB interest rates, for the three key rates and the dates and sizes of changes to the deposit facility rate since 2022.
- US Bureau of Economic Analysis, U.S. international transactions and investment position, 2nd quarter 2026 (news release, 24 September 2026), for the current account, financial account, first-quarter components and the net international investment position.
- The Coca-Cola Company, Fourth quarter and full year 2025 results (Form 8-K, Exhibit 99.1), for net revenues, the organic, structural and currency components of growth, comparable currency neutral operating income and the 2026 currency outlook.
- McDonald’s Corporation, Fourth quarter and full year 2025 results (11 February 2026), for consolidated revenues, operating income and diluted earnings per share, reported and in constant currencies.
How the numbers were checked: every percentage change, the inverse rates, the forward rate, the sum of the current-account components and the calculator figures were recomputed in plain code from the values in the sources above. The calculator, which runs separately, was compared with that code for every combination of settings it allows. The McDonald’s currency gaps are calculated from rounded published growth rates, and the text says so.