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MacroEconomics > 15 - Exchange Rate Systems > Flashcards

15 - Exchange Rate Systems Flashcards

1
Q

What are Exchange rates?

A

The value of one currency in relation to another.

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2
Q

Which factors determine exchange rates?

A

Changes in income of foreigners, changes in relative prices, changes in investment prospects, changes in relative interest rates, use of foreign reserves.

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3
Q

What are the two ways to show appreciations of exchange rate?

A

Increase in demand, decrease in supply.

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4
Q

What are the two ways to show depreciation of exchange rate?

A

Increase in supply, decrease in demand.

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5
Q

What does SPICED stand for?

A

Strong Pound Imports Cheaper Exports Dearer.

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6
Q

What does WPIDEC stand for?

A

Weak Pound Imports Dearer Exports Cheaper.

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7
Q

What are floating exchange rates?

A

Exchange rate is determined by interplay of demand for currency.

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8
Q

What is the impact of the floating exchange rate diagram?

A

If the exchange rate of the pound falls, UK exports are more competitive in overseas markets. Volume of UK exports increase, leads to greater overseas demand.

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9
Q

What is the impact of a currency having to adjust to a new equilibrium rate?

A

Increased demand for imports after improvement in quality of goods, UK residents supply or sell more pounds, overseas residents still demand the same quantity of UK goods.

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10
Q

What are the advantages of floating exchange rates?

A

Automatically achieving balance of payments equilibrium, improving resource allocation, freedom to achieve domestic policy objectives, easier to control inflation, ability to pursue an independent monetary policy.

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11
Q

How does a floating exchange rate help achieve BOP equilibrium?

A

Exchange rate should move up or down automatically to correct imbalances.

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12
Q

How does a floating exchange rate improve resource allocation?

A

If the world’s resources are to be efficiently allocated between competing uses, exchange rates must be correctly valued.

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13
Q

How does a floating exchange rate give freedom to achieve domestic policy objectives?

A

Governments are free to pursue objectives, as market forces are in charge of the current account of the balance of payments.

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14
Q

How do floating exchange rates give freedom to control inflation?

A

Exchange rates insulate the country against importing inflation from the rest of the world. If inflation rates are higher elsewhere, floating rates lower the price of imports.

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15
Q

How does a floating exchange rate give freedom to pursue an independent monetary policy?

A

Monetary policy can be used to achieve domestic policy objectives - controlling inflation, rather than being used to prevent the exchange rate from falling.

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16
Q

What are the disadvantages of floating exchange rates?

A

Effects of speculation and capital flows, international trading uncertainty, could cause cost push inflation, could cause demand pull inflation.

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17
Q

How does speculation affect floating exchange rates?

A

Over 90% of currency transactions taking place on forex markets stem from capital flows. Hot money flows. Currencies which speculators believe are over valued will be sold.

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18
Q

How do floating exchange rates affect international trading uncertainty?

A

Can slow the growth of international trade. Companies can’t be sure how much domestic currency they will have to pay for imports, receive from exports.

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19
Q

How could floating exchange rates cause cost push inflation?

A

Speculation causes exchange rate to fall, increasing import prices, raising the rate of cost push inflation, causes a wage price spiral.

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20
Q

How could floating exchange rates cause demand pull inflation?

A

Can trigger DPI, as there is no need to deflate the domestic economy. This can lead to excess demand globally, fuelling global inflation.

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21
Q

What are fixed exchange rates?

A

A system in which the government of a country agrees to fix the value of its currency against that of another country.

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22
Q

What are the key features of a fixed exchange rate?

A

The central bank is given responsibility for maintaining the fixed exchange rate. If the exchange rate remains inside the zone of flexibility, intervention isn’t needed.

23
Q

What happens if demand or supply curves shift to a new position?

A

Market forces could take the exchange rate above the ceiling or below the floor.

24
Q

What are the effects of China’s fixed exchange rate?

A

Yuan is fixed against US dollar at P. Demand for Yuan exceeds supply of Yuan. Exports are cheaper, imports are more expensive. Surplus on the balance of payments.

25
Q

What are the effects of fixed exchange rates above the equilibrium in general?

A

Supply exceeds demand, consumers demand cheaper imports, widening trade deficit, excess supply represents the amount that the central bank must buy back with foreign currency.

26
Q

What are the advantages of fixed exchange rates?

A

Attempt to achieve certainty and stability in forex markets. Low costs to remain competitive. Anti inflationary discipline on domestic economic management. Increased trade.

27
Q

What are the disadvantages of fixed exchange rates?

A

Could increase uncertainty if a devaluation is expected to occur. A fixed rate being over valued may impose deflationary costs from cost output and unemployment. Monetary policy isn’t independent. Domestic policy is directed by international trade.

28
Q

What does an undervalued exchange rate mean?

A

Inflation is imported from the rest of the world.

29
Q

What does a central bank have to do if there is no automatic adjustment of rates?

A

Intervene by buying government bonds.

30
Q

How can governments influence the exchange rate?

A

Buying or selling its’ own currency on the foreign exchange market. Raising or lowering bank rate to keep the pounds exchange rate between the zone.

31
Q

What is a currency union?

A

An agreement between a group of countries to share a common currency to have a single monetary and foreign exchange rate policy.

32
Q

What are two examples of currency unions?

A

Pound and Dollar - UK and USA.

33
Q

What are the characteristics of the Eurozone?

A

Came into existence in 2022. Maastricht treaty started, creating the monetary union. Transaction costs decreased after the single currency was taken into place, no need to exchange national currencies. 20 member states are currently in the eurozone.

34
Q

How does mobility of labour fit inside the EU?

A

There is freedom of movement inside the EU, mobility of labour and common fiscal policy are essential if a common currency area becomes an optimal currency area.

35
Q

How can a country restore competitiveness inside a currency zone?

A

Devaluing currency.

36
Q

How can a country solve problems of high unemployment?

A

A high degree of labour mobility.

37
Q

What is the importance of common fiscal policy?

A

Allows wealth to be transferred by a centralised fiscal authority from richer to poorer parts of a union. Can improve competitiveness of poorer regions.

38
Q

What does the ECB have?

A

Monetary policy co-ordination.

39
Q

What has the lack of a common fiscal policy led to?

A

Some eurozone countries having high levels of government debt.

40
Q

What are the advantages of the Euro?

A

Transaction costs decrease within eurozone countries, reduction in exchange rate uncertainty, increased competition - increase in consumer surplus. Greater price transparency. ECB has control of interest rates.

41
Q

What are the disadvantages of the Euro?

A

No control over interest rates leads to inflation. More emphasis must be placed on fiscal policy. Expensive introductory costs.

42
Q

What are the benefits of trading in the EU?

A

Greater competition - good for firms and consumers. Removal of trade barriers, reduction of business costs, greater business efficiency.

43
Q

What are the disadvantages of trading in the EU?

A

Cost - EU membership cost the UK £15 Billion. Inefficient Policies - 40% of EU spending goes on common agricultural policy. Net migration causes overcrowding.

44
Q

What does the change in exchange rates depend on?

A

Elasticity of X and M, supply side policies being introduced - long run competitiveness. If currency appreciates or depreciates. The cause.

45
Q

What do Central banks do when the value of the £ falls?

A

Sells reserves of other currencies, value of £ has appreciated, quantity demand of £ has increased, CB intervenes to create stability and confidence.

46
Q

Which factors affect competitiveness of a currency?

A

Inflation, price and non-price factors, capital movements, speculation.

47
Q

What are the limitations of purchasing power parity?

A

Trade barriers such as tariffs, distort market prices. Ignores transportation costs, insurance and banking costs, higher profit margins.

48
Q

What happens to the exchange rate when interest rates rise?

A

Appreciate - due to hot money flows.

49
Q

What happens to the exchange rate when the UK central bank sells pound sterling?

A

Depreciates - Due to increased supply.

50
Q

What happens to the exchange rate when inflation rises, compared to other economies?

A

Depreciates - demand for exports falls, currency falls.

51
Q

What happens to the exchange rate when Euro average incomes increase?

A

Appreciate - due to demanding more exports.

52
Q

What happens to the exchange rate when investors have low confidence in UK growth?

A

Depreciates - due to demand being less than supply.

53
Q

What are Hot money flows?

A

UK interest rate rises, foreign investors transfer their currency to purchase the pound. Foreign investors can deposit their funds into bank accounts, gaining an overnight return. Investors sell the pound the next day.

MacroEconomics (15 decks)

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