Currency conversion sits at the intersection of everyday practicality and complex economic forces. At the surface, converting dollars to euros is simple arithmetic. Underneath that arithmetic, the exchange rate is the product of interest rates, inflation expectations, trade flows, political stability, speculative activity, and central bank policy across two countries. Understanding why exchange rates are what they are does not change the calculation, but it does explain why the rate you see today differs from the one you saw last month.

For most people the currency converter is a tool for travel planning, online shopping from foreign retailers, sending money internationally, or tracking the value of foreign assets. The quality of the conversion depends on which rate is being applied, and different contexts use meaningfully different rates.

The difference between mid-market, buy and sell rates

The mid-market rate, sometimes called the interbank rate or spot rate, is the midpoint between the price at which banks buy and sell a currency. It is the rate you see on financial data sites and in the news when exchange rates are reported. This is not the rate most consumers actually get when converting money.

Banks and currency exchange services make their profit by buying currency at a rate below the mid-market rate and selling it at a rate above it. The difference between these two rates is called the spread. A credit card company converts at a rate close to mid-market but adds a foreign transaction fee on top. A currency exchange kiosk at an airport applies a large spread that can represent 5 to 10 percent worse rate than mid-market. Online transfer services vary widely from nearly mid-market to significantly below it.

When planning international travel or comparing money transfer services, comparing the effective rate you will receive against the mid-market rate gives you a clear measure of the actual cost. A service that advertises no fees but applies a 3 percent spread is more expensive than one that charges a flat fee and converts at mid-market.

Why exchange rates change constantly

Currency markets operate continuously, and exchange rates change every second during trading hours. The drivers of these movements operate on different timescales. Long-term fundamentals like productivity differences between economies and current account balances drive trends over months and years. Medium-term factors like interest rate decisions and inflation data cause significant movements over days and weeks. Short-term factors like geopolitical events, news releases and shifts in investor sentiment cause movements minute to minute.

Central banks are the most powerful actors in currency markets because they can intervene directly. A central bank that raises interest rates makes the currency more attractive to investors seeking yield, which typically causes the currency to appreciate. A bank that cuts rates has the opposite effect. When major central banks like the Federal Reserve, the European Central Bank or the Bank of Japan make decisions or signal their intentions, currency markets respond immediately and sometimes dramatically.

Economic data releases also move rates. A stronger than expected jobs report in the US suggests the economy is performing well and can sustain higher interest rates, which tends to strengthen the dollar. Inflation data that comes in above expectations suggests a central bank may need to raise rates to control it, which can also strengthen the currency. Traders and institutions position themselves ahead of these announcements and adjust rapidly when the actual data differs from expectations.

Purchasing power parity

Purchasing power parity is an economic concept that suggests exchange rates should in theory equalize the prices of identical goods across countries. If a product costs $10 in the US and the same product costs the equivalent of $6 at current exchange rates in another country, purchasing power parity theory suggests the currency is undervalued relative to the dollar and should appreciate over time.

In practice, exchange rates deviate from purchasing power parity for long periods due to capital flows, trade barriers, non-tradeable goods and services, and speculative activity. The concept is more useful as a long-term reference point for whether a currency appears fundamentally under or overvalued than as a predictor of near-term movements.

The Economist's Big Mac Index applies this concept in a simplified and accessible form by comparing the price of a McDonald's Big Mac across countries in a common currency. While obviously not a complete picture of purchasing power, it has historically correlated reasonably well with economist models of fair value and serves as an accessible illustration of the concept.

Practical tips for currency conversion

For travel, withdrawing local currency from ATMs abroad typically gives better rates than airport exchange kiosks. ATMs connected to global networks like Visa and Mastercard apply rates close to interbank, though the issuing bank may add a foreign transaction fee. Checking your bank's policy on foreign ATM fees before traveling tells you whether using your home bank card or getting a travel card with no foreign fees is the better option.

For online purchases from foreign retailers, paying in the retailer's local currency rather than your home currency is almost always better. Many payment pages offer dynamic currency conversion, which converts the price to your home currency at checkout. This sounds convenient but the rate applied by the retailer's payment processor is typically worse than the rate your card would apply. Choosing to pay in the foreign currency lets your card company handle the conversion at a more favorable rate.

1. Open the Currency Converter below.
2. Enter the amount you want to convert.
3. Select the source and target currencies.
4. See the converted amount at the current mid-market rate.