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A-level - Economics Yr13 Mine > 15 - Exchange Rate Systems and Economic Growth and Development > Flashcards

15 - Exchange Rate Systems and Economic Growth and Development Flashcards

1
Q

What is exchange rate?

A

The exchange rate of a currency is the weight of one currency relative to another. External price of currency.

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2
Q

What are the two types of exchange rates?

A

Free-floating exchange rate.
Fixed exchange rate.

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3
Q

What is a freely floating exchange rate?

A

The value of the exchange rate in a floating system is determines by the market forces of supply and demand.

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4
Q

What are the characteristics of a free floating exchange rates?

A
  • Currency value set by market forces
  • No intervention by the central banks
  • No target for the exchange rate
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5
Q
A
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6
Q

Draw a graph for Free Floating Exchange Rates.

A

Same as supply and demand graph but with different y and x axis

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7
Q

What is a fixed exchange rate?

A

A fixed exchange rate has a value determined by the government/central bank compared to other currencies.

The government announces that an exchange estate is being fixed (pegged) at a particular rate

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8
Q

What are the characteristics of a Fixed Exchange Rate?

A
  • Government/Central Banks fixes currency value
    External value is pegged to one or more countries
    The central Bank must hold sufficient RESERVES, in order to intervene in currency markets to maintain fixed peg
  • Pegged exchange rate becomes official rate.
    Trade takes place at this official exchange rate.
    There might be unofficial trades in shadow currency markets.
  • Adjustable peg
    Occasional realignments needed. E.g a devaluation or revaluation on economic circumstances, currency drifted from fundamental value.
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9
Q

Why did Gordon Brown sell a lot of the UKs gold reserves?

A

The UK is a free-floating exchange rate so does not need reserves, so did not need the gold reserves.

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10
Q

Explain simply how a fixed exchange rate works for a government.

A

The government announces that an exchange estate is being fixed (pegged) at a particular rate. And then the central bank is given responsibility for maintaining that rate. Normally called the Central Peg.

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11
Q

Which exchange rate uses depreciation and which one uses devaluation?

A

Floating exchange rate uses depreciation/appreciation.

Fixed exchange rate uses devaluation/revaluation

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12
Q

What does appreciation and depreciation mean?

A

Appreciation = increase in the value of an exchange rate.

Depreciation = decrease in the value of exchange rate

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13
Q

Draw a diagram for an appreciation of a currency from a rise in demand, and explain it?
(Floating Exchange Rate)

A
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14
Q

What would cause an increase in demand for an free-floating exchange rate?

A

Bank of England raises interest rates, leads to inflow of hot money money into UK banks, increased demand for sterling among speculators. Currency appreciation.

Improvement of the Uk goods or services, more exports. Increased demand, current account into surplus, causing the pounds exchange rate to appreciate. And relieve excess demand for pounds.

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15
Q

What is hot money?

A

“Hot money” refers to short-term investments or funds that are rapidly moved between countries or financial markets in search of the highest short-term return or interest rates. It typically refers to speculative capital that flows into or out of a country, taking advantage of interest rate differentials, exchange rate fluctuations, or other market opportunities. Exploit temporary profits as there is more return on investment.

Invest money and more return from higher interest when paying it back.

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16
Q

What is economic growth?

A

Economic growth is the increase in a country’s real national output. This is caused by increases in the quality or quantity of factors of production, which cause an outward shift in the PPF.

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17
Q

What is economic development?

A

Economic development refers to living standards, freedom (from oppression) and life expectancy. Essentially, it covers a more moral side to economic growth and it is normative. Development is also concerned with how sustainable the economy is and whether the needs of future generations can be met.

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18
Q

Does economic growth mean there will be economic development?

A

No, a country could be selling more exports but then the government is using this money to buy military equipment to kill citizens who try to uprise and change the leadership.

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19
Q

What are the main characteristics of less-developed countries?

A
  • Low life expectancies
  • High mortality rates
  • High dependency ratio (greater burden to support services needed by children/older people/dependent).
  • Low GDP
  • Fast population growth
  • Low levels of education
  • Poor standard of living
  • Poor nutrition, lack of access to clean, safe drinking water and a lack of sanitation
  • Poor or absent health care provision
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20
Q

What is the name of the famous economists and what did he say is a main characteristics of less developed countries?

A

W.W. Rostow

Used term ‘traditional society’ as little changes from generation to generation. Causing low economic growth from usually agricultures having little innovation in the methods of production and therefore the output of production not increasing.

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21
Q

What is the Human Development Index (HDI)?

A

HDI is a broad measure of improvements in people’s lives.

HDI is calculated through a geometric mean of GDP per capita, life expectancy at birth, and average between mean years of schooling and expected years of schooling. Each components has an equal 33% weighting.

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22
Q

What are the components of the Human Development Index?

A
  1. Knowledge: An education comptent made up of two statistics (i) mean years of schooling (ii) expected years of schooling.
  2. Life Expectancy: calculated using a minimum value for life expectancy of 25 years and maximum value of 85 years.
  3. A decent standard of living: using GNI (gross National income) per capita adjusted to purchasing power parity standard (PPP) in US dollars.
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23
Q

What are countries with high HDI and low HDI?

A

1st HDI rank is Norway
2nd Switzerland

13th USA
14th United Kingdom

187 th Sudan, civil war.
188th rank is Niger very low life expectancy, very little health care, and average years of schooling 2.0.

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24
Q

What does the values HDI can take and what do they mean?

A

0 to 1

A value close to 1 is indicative of a high level of economic development, 0 suggest of a low level of development.

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25
Q

What is an example of a country, which shows how HDI is not a great indicator of development?

A

Equatorial Guinea has very low life expectancy and education, but have a very high GNI due to having lots of oil.

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26
Q

Why and what value has the average world HDI rose to?

A

The average world HDI rose from 0.48 in 1970 to 0.68 in 2010. Mainly due to the growth of East Asia, the pacific and South Asia (China especially).

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27
Q

What is interesting about the US HDI?

A

13th
Is not at the very top due to a relatively low life expectancy, form the diet of the Americans and bad health care system.

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28
Q

Why do many African and Middle Eastern countries have very low mean years of schooling?

A

Because many of these countries do not allow for women to go the school

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29
Q

What is aid?

A

Money, goods and services and ‘soft loans’ given by the government of country’s or organisations to help another country.

People argue aid promotes economic development more than trade.

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30
Q

What are the different types of Aid?

A
  • Military Aid
  • A ‘hard’ loan
  • A ‘soft’ loan
  • Disaster Relief
  • ‘Tied’ aid
  • Technical Assistance
  • Debt Relief
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31
Q

What is military aid?

A

Aid (usually money) has to be spent buying the weaponry of the donor country, questionable whether it can be classified as aid.

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32
Q

What does a ‘hard’ loan and ‘soft’ loan mean? (Type of aid)

A

‘Hard’ Loan - A loan (usually hard money), has to be paid back at market rate of interest.

‘Soft’ Loan - A loan made to a country, has to be paid back at a below-market rate of interest or no interest.

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33
Q

What is disaster relief? (Example aswell)

A

Usually given by non-governmental organisations (NGOs), like Oxfam, it is humanitarian aid such as food and clothes from a natural disaster or other disaster.

Like in Nepal earthquake in 2015 uk government supplied aid.

Some NGOs are corrupt, OXFAM sexually abusing children in Haiti after the earthquake.

However this aid stops human cost but does not really promote economic development, as in Sudan war and famine has not stopped so they have become dependent on the aid to survive. Not Development.

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34
Q

What is ‘Tied’ Aid?

A

Take the form of a ‘soft’ loan or gift of money but must be paid back in exports, usually natural resources, same as the money given or more give back for free.

Countries can exploit developing countries.

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35
Q

What is Technical assistance? (Aid) example,and how does this increase economic development?

A

Lending their experts or funding expertise to less economically developed countries.

Africa has been the top recipient of Chinese aid. Build infrastructure especially transport routes train lines, roads. However they employ Chinese workers and extort the countries of their natural resources.

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36
Q

What is debt relief? and how does it promote development?

A

It is partial or total forgiveness of debt.

Debt can be a cause of poverty as financial resources are diverted from infrastructure, education and healthcare.

Debt forgiveness can allow a country to import more and increase populations standard of living, improves government finances, to be spent on public services.

However, forgiveness could encourage more borrowing in future and corruption.

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37
Q

What are the Pros of overseas aid?

A
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38
Q

What are the Cons of Oversea aid?

A

A

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39
Q

What is the difference between growth and development?

A
  • Economic growth is the increase in a country’s real national output
  • This is caused by increases in the quality or quantity of factors of production, which cause an outward shift in the PPF.
  • Economic development refers to living standards, freedom (from oppression) and life expectancy.
  • It covers a more moral side to economic growth and it is normative.
  • Development is also concerned with how sustainable the economy is and whether the needs of future generations can be met.
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40
Q

What is ‘indicators of development’?

A

Includes gross domestic product (GDP) per head, information on the distribution of income, morality rates and health statistics

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41
Q

What is the United Nations Human Development Index (HDI)?

A

An index based on life expectancy, education and per capita income indicators, which ranks the world’s countries into four tiers of human development. These are: (i) very human development, (ii) high human development, (iii) medium human development, (iv) low human development

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42
Q

What does HDI measure?

A

Measures economic and social welfare of countries over time

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43
Q

How does the component of education work under HDI?

A

It combines the statistics of the mean number of years of schooling and the expected years of schooling

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44
Q

How does the component of life expectancy work under HDI?

A

Uses a life expectancy range of 25 to 85 years.

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45
Q

How does the component of standard of living work under HDI?

A
  • Measures GNI adjusted to PPP per capita.
  • GDP was used instead of GNI, but to account for remittances and foreign aid, GNI is now used, since it reflects average income per person
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46
Q

How do you tell high or low level of economic development when using HDI?

A
  • A value close to 1 is indicative of a high level of economic development
  • A value close to 0 suggests a low level of development
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47
Q

What’re the advantages of using the HDI to compare levels of development between countries and over time?

A
  • Allows for comparisons between countries to be made, based upon which countries are generally more developed than other countries
  • Provides a much broader comparison between countries than GDP does
  • Education and health are important development factors to consider, and it can provide information about the country’s infrastructure and opportunities. It also shows how successful government policies have been
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48
Q

What’re the limitations of using the HDI to compare levels of development between countries and over time?

A
  • HDI does not consider how free people are politically, their human rights, gender equality or people’s cultural identity.
  • HDI does not take the environment into account. It could be argued that this should be included to focus on human development more.
  • HDI does not consider the distribution of income. A country could have a high HDI but be very unequal. This can mean many people might still be in poverty.
49
Q

What are other indicators of development that can be used?

A
  • Human Poverty Index (HPI)
  • Gender-related Development Index (GDI)
50
Q

What is the Human Poverty Index (HPI)?

A
  • It measures life expectancy, education and the ability of citizens to meet basic needs.
  • There are two types: HPI-1 and HPI-2. The former measures poverty in developing countries and the latter measures poverty in developed countries.
51
Q

How is HPI-1 different to HPI-2 (Human Poverty Index)?

A
  • In HPI-1, the longevity part of the index measures the probability of living to the age of 40
  • The education component considers the adult literacy rate
  • The ability of citizens to meet basic needs is measured by the percentage of underweight children and the percentage of people not using improved water sources.
52
Q

How is HPI-2 different to HPI-1 (Human Poverty Index)?

A
  • For HPI-2, the probability of not surviving to at least the age of 60 is used
  • The percentage of adults which do not have literacy skills is calculated, and poverty is calculated by those living below the poverty line
  • This is below 50% of median income.
53
Q

What is the Gender-related Development Index (GDI)?

A

It measures the relative inequality between men and women
- It combines HDI with a consideration of gender. E.g., it will consider differences in life expectancies, income and education between genders.

54
Q

What are the measures that can be used which make the economy free with minimum government intervention?

A
  • Trade liberalisation
  • Promotion of FDI
  • Removal of government subsidies
  • Floating exchange rate systems
  • Microfinance schemes
  • Privatisation
55
Q

How is ‘trade liberalisation’ a measure which makes the economy more free, with minimum government intervention?

A
  • Free trade is the act of trading between nations without protectionist barriers, such as tariffs, quotas or regulations
  • World GDP can be increased using free trade, since output increases when countries specialise
  • Therefore, living standards might increase and there could be more economic growth
56
Q

How is ‘promotion of FDI’ a measure which makes the economy more free, with minimum government intervention?

A
  • FDI is the flow of capital from one country to another, in order to gain a
    lasting interest in an enterprise in the foreign country.
  • FDI can help create employment, encourage the innovation of technology and help promote long term sustainable growth. It provides LEDCs with funds to invest and develop.
57
Q

How is ‘removal of government subsidies’ a measure which makes the economy more free, with minimum government intervention?

A
  • Government subsidies could distort price signals by distorting the free market mechanism
  • A free market economist would argue that this could lead to government failure. There could be an inefficient allocation of resources because the market mechanism is not able to act freely
  • E.g. The government might end up subsidising an industry which is failing to has few products
58
Q

How is ‘floating exchange rate systems’ a measure which makes the economy more free, with minimum government intervention?

A

The value of the exchange rate in a floating system is determined by the forces of supply and demand

59
Q

What is microfinance?

A
  • Provision of financial services
  • Involves borrowing small amounts of money from lenders to finance enterprises
60
Q

How is ‘Microfinance schemes’ a measure which makes the economy more free, with minimum government intervention?

A
  • It increases the incomes of those who borrow, and can reduce their dependency on primary products
  • It allows them to break away from aid and gives borrowers financial independence
  • Microfinance loans detach the poor from high interest, exploitative loan sharks. They could help businesses to be set up.
  • Since the money goes directly to Small and Midsized Enterprises (SMEs), it can stimulate employment
61
Q

How does privatisation work?

A
  • The government sells a firm so that is no longer in their control
  • The firm is left to the free market and private individuals
62
Q

How is ‘Privatisation’ a measure which makes the economy more free, with minimum government intervention?

A
  • Economists will argue that the private sector gives firms incentives to operate efficiently, which increases economic welfare as firms operating on the free market have a profit incentive, which firms which are nationalised don’t
  • Firms have to produce the goods and services consumers want which increases allocative efficiency and might mean goods and services are of a higher quality
  • By selling the asset, revenue is raised for the government (this is only a one-off payment)
63
Q

How does the government intervene in the market to try and influence growth and development?

A

By using interventionist strategies

64
Q

What are interventionist strategies that the government can use to try and influence growth and development?

A
  • Development of human capital
  • Protectionism
  • Managed exchange rates
  • Infrastructure development
  • Promoting joint ventures with global companies
  • Buffer stock schemes
65
Q

How does the interventionist strategy of ‘development of human capital’ influence growth and development?

A
  • The skills base in the economy would improve and this would improve productivity and allow more advanced technology to be used as workers will have the necessary skills
  • Businesses struggle to expand where there are skills shortages. It also limits innovation
  • By developing human capital, the country can move their production up the supply chain from primary products, to manufactured goods and to services which can earn them more
66
Q

How does the interventionist strategy of ‘protectionism’ influence growth and development?

A
  • Can help reduce a trade deficit as they will be importing less due to tariffs and quotas on imports
  • Can protect infant industries
  • Is usually short term until the industry develops, at which point the industry can trade freely
  • Does have risks e.g. could distort the market, lead to a loss of allocative efficiency, tariffs being regressive, etc.
67
Q

How does the interventionist strategy of ‘managed exchanged rates’ influence growth and development?

A
  • It combines the characteristics of fixed and floating exchange rate systems
  • This is when the exchange rate floats on the market, but the central bank of the country buys and sells currencies to try and influence their exchange rate
68
Q

How does the interventionist strategy of ‘Infrastructure development’ influence growth and development?

A
  • E.g. transport, energy, water and telecommunications
  • Lack of development can lead to e.g. rising food prices, reoccurring power cuts leading to electricity affecting transport and more
  • Employment can be boosted with improved roads, railways and airport constructions
69
Q

When do joint ventures occur?

A

When a partnership is formed between two firms based in multiple countries

70
Q

How does the interventionist strategy of ‘Promoting joint ventures with global companies’ influence growth and development?

A
  • Allows the firm to participate in international trade, without the responsibilities involved of it
  • Helps technological knowledge to be transferred, which can help improve and develop small companies
  • They open up new markets for small firms, so they can distribute their products to customers
  • Spreads their risk
  • Helps firms penetrate a foreign market (usually difficult due to barriers to entry)
71
Q

How does the interventionist strategy of ‘Buffer stock schemes’ influence growth and development?

A
  • Could help reduce price volatility in the agriculture market
  • Helps incomes of farmers to remain stable as fluctuations in the market are reduced and increases consumer welfare
72
Q

What are barriers to growth and development?

A
  • Primary product dependency
  • Savings gap: Harrod-Domar model
  • Debt
  • Access to credit and banking
  • Infrastructure
  • Education/skills
  • Corruption
  • etc.
73
Q

What are primary products?

A

Raw materials in industries e.g. agriculture, mining and forestry

74
Q

How is ‘primary product dependency’ a barrier to growth and development?

A
  • When developing countries rely on these products this could lead to volatility of commodity prices that can make it hard for workers to plan for the future, and it means incomes of farmers are hard to predict
  • A fall in the price leads to a fall in export incomes making it hard to fund their infrastructure and education
  • Relying on these products isn’t sustainable as they could be over extracted and run out
75
Q

How is ‘savings gap: Harrod-Domar model’ a barrier to growth and development?

A
  • In developing countries, there is only limited wealth, which means money cannot be put aside for the future, and they can only afford to spend in the short run
  • The model states that investment, saving and technological change are required in an economy for economic growth. The rate of growth increases if the savings ratio increases. This leads to increased investment and technological progress, which leads to higher productivity
  • Growth will increase with more saving or a small capital output ratio
76
Q

What are the possible limitations of the Harrod-Domar model?

A

There’s a low marginal propensity to save in some countries, or that there might be a poor financial system
- Funds might not lead to borrowing and investment
- Could be inefficiency in the workforce

77
Q

How is ‘debt’ a barrier to growth and development?

A

The debt crisis emerging in the developing world threatens the fight against poverty and inequality

78
Q

How is ‘access to credit and banking’ a barrier to growth and development?

A

Without a safe, secure and stable banking system, there is unlikely to be a lot of saving in a country

79
Q

How is ‘infrastructure’ a barrier to growth and development?

A
  • Poor infrastructure discourages MNCs from setting up premises in the country.
  • This is since production costs increase where basic infrastructure, such as a continuous supply of electricity, is not available.
80
Q

How is ‘education/skills’ a barrier to growth and development?

A
  • Important for developing human capital
  • Adequate human capital ensures the economy can be productive and produce goods and services of a high quality
  • Helps generate employment and raise standards of living
81
Q

How is ‘corruption’ a barrier to growth and development?

A
  • Prevents normal economic activity from taking place
  • Corruption diverts scarce resources away from more productive uses to protect less efficient resource use
  • Production costs and consumer prices will rise
82
Q

Examples of countries fully-fixed exchange rate?

A
  • Saudi Arabia (fixed to US Dollar)
  • Denmark (fixed to the Euro)
83
Q

What policies might be adopted to promote economic growth and development?

A
  • Macroeconomic and microeconomic government policies e.g. demand-side fiscal policy and monetary policy, supply-side policy
  • Redistributive policies
  • Foreign exchange controls
84
Q

Draw a fixed exchange rate diagram?

(Semi fixed)

A
85
Q

Explain this fixed rate exchange diagram.

A
86
Q

Explain how the government increases supply of money in a fixed exchange rate has an effect.

A

In a fixed exchange rate system, the supply of the currency can be manipulated by the central bank, which can buy or sell the currency to change the price to where they want. In the diagram, the supply has been increased (S1 to S2) by selling the currency so more is on the market (Q1 to Q3). The currency depreciates as a result (P2 to P3), which makes exports more competitive.

87
Q

Explain the fixed exchange rate diagram.

A

Supply has fallen from S1 to S2 possibly from speculative selling of currency. This drives the market price below the low level. This requires the central bank to intervene. The central bank buys up their own currency. Which therefore increases the demand of the currency as there is less on the market, increasing the exchange rate price so it is above the lower price.

88
Q

Examples of countries with floating exchange rates.

A
  • US dollar
  • Japan
  • Australia
  • UK sterling
89
Q

What is a managed exchange rate?

A

Managed exchange rate systems combine the characteristics of fixed and floating exchange rate systems. The currency fluctuates, but it doesn’t float on a fully free market. This is when the exchange rate floats on the market, but the central bank of the country buys and sells currencies to try and influence their exchange rate.

90
Q

Why has China tried to influence their currency?

A

China has previously kept the Yuan undervalued by buying US dollar assets to make their exports seem relatively cheaper.

91
Q

How can interest rates affect exchange rate?

A

An increase in interest rates, relative to other countries, makes it more attractive to invest funds in the country because the rate of return on investment is higher. This increases demand for the currency, causing an appreciation. This is known as hot money.

92
Q

How can Quantative Easing affect exchange rate?

A

This is used by banks to help to stimulate the economy when standard monetary policy is no longer effective. This has inflationary effects since it increases the money supply, and it can reduce the value of the currency. QE is usually used where inflation is low and it is not possible to lower interest rates further.

93
Q

How can foreign currency transaction affect exchange rate?

A

The Bank of England uses this to manage the UK’s gold and foreign currency reserves, as well as managing the MPC’s pool of foreign currency reserves. It involves buying and selling foreign currency to manipulate the domestic currency. China kept large reserves of the US Dollar by purchasing government bonds, in order to undervalue the Yuan.

94
Q

What are the advantages of a floating exchange rate?

A

1) Reduce Need for currency Reserves
2) Freedom for domestic monetary policy
3) Automatically Achieving balance of payments equilibrium.
4) Improving Resource Allocation

95
Q

What are the disadvantages of Floating Exchange Rates?

A
  1. Volatility and capital inflows
  2. International Trade Uncertainty
  3. May cause Cost-Push inflation
  4. May cause Demand-Pull inflation
96
Q

What are the advantages of fixed exchange rates?

A
  1. Low Exchange Rate Uncertainty
  2. Reduction in the Cost of Trade
  3. Discipline on domestic producer
97
Q

How is reduce the need for currency reserves an advantage of floating exchange rates?

A

When you maintain fixed exchange rates, government need large level of domestic currency but also foreign currency. This is extremely costly. Don’t need this in floating.

98
Q

How is freedom for domestic monetary policy for an advantage of floating exchange rates?

A

Allows you to set interest rates for domestic needs, such as to control inflation. Whereas a fixed exchange rate will be determined by events in the outside world, so will not be solely domestic. As a fixed exchange rate has to change interest rates to keep a same fixed exchange rate. In a fixed economy exchange rate system, domestic objectives are often sacrificed to the pursuit of the external policy objective of maintaining an exchange rate target.

99
Q

How is automatically achieving a balance of payment equilibrium an advantage of floating exchange rates?

A
100
Q

How is improving resource allocation an advantage of floating exchange rates?

A

For efficient resource allocation, market prices must accurately reflect shifts in demand and changes in compétitivity in the world, such as new invention or discovery of materials. Free floating exchange rates should respond to this. A fixed exchange rate will become eventually become OVERVALUED OR UNDERVALUED as competition changes and s demand

101
Q

How is volatility and uncertainty an disadvantage of floating exchange rates?

A

One of the most significant drawbacks of a free-floating system is the potential for exchange rate volatility. Currencies can experience rapid and unpredictable fluctuations, which can introduce uncertainty for businesses engaged in international trade and investment. Less Businesses confidence, therefore less FDI and investment for businesses. Investment planning difficult

102
Q

How is international trading uncertainty an disadvantage of floating exchange rates?

A

It can also affect the exports and imports of a country, which could cause a lot of unemployment if an industry is affected in particular.

For example, higher exchange rates more imports less exports, as exports are less competitive.

103
Q

How is possible cost-push inflation a disadvantage of floating exchange rates?

A

If a country has a higher rate of inflation then it will lose trading competition with other competitors and the exchange rate will have to fall to restore competitiveness.
Falling exchange rate increases import prices, which raise the rate of domestic cost-push inflation.
Workers react by demanding a higher wages to be be able to pay for the higher prices goods.
This increased inflation then eroded the export competitiveness initially won by the fall of the exchange rate.
Eventually causing another fall in the exchange rate, so the spiral continues.

104
Q

How is possible demand-pull inflation an disadvantage of floating exchange rates?

A

A fall in the exchange rate causes a shift in AD which can create demand-pull inflation if increases too much (use knowledge of demand-pull inflation).

105
Q

How is lower exchange rate uncertainty an advantage of fixed exchange rates?

A

Allows for firms to plan investment, because they know that they will not be affected by harsh fluctuations in the exchange rate. Higher business confidence. Higher FDI. Trade is a lot easier.

106
Q

How is Reduction in the Cost of Trade an advantage of fixed exchange rates?

A

Currency hedging - buying your currency in advance as you believe it will change in price. But in a fixed exchange rate you do not have to worry about this.

107
Q

How is Discipline on domestic producer an advantage of fixed exchange rates?

A
  • To maintain competitiveness, the only way firms can ensure this is by increasing efficiency and innovation, as the exchange rate will not change to increase exports. Promotes efficiency. Creates lower prices for consumer in the long run.
  • Poses an anti-inflationary discipline on a country aswell.
108
Q

What are the disadvantages of a Fixed Exchange Rate?

A
  • Balance of payments distribution
  • Large foreign currency reserves needed
  • Overvalued and undervalued currency
  • Reduced Freedom of using interest rates and monetary policy as tools.
109
Q

How is a disruption in the balance of payment a disadvantage of Fixed Exchange Rates?

A

The balance of payments does not automatically adjust to economic shocks.

110
Q

How is holding reserves a disadvantage of Fixed Exchange Rates?

A

It can be costly and difficult for the government to hold large reserves of foreign currencies.

111
Q

How is undervalued and overvalued currency a disadvantage of Fixed Exchange Rates?

A

The government and the central bank do not necessarily know better than the market where the currency should be, do not have perfect information.

112
Q

What is a currency Union?

A

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

113
Q

What is a monetary Union?

A

Members of a monetary union share the same currency.

114
Q

What is an example of monetary policy (currency Union)?

A

The Eurozone.

A common central monetary policy is established when a monetary union is formed. The single European currency, the Euro, was implemented in 1999 to form the Eurozone.

115
Q

Explain how monetary unions (currency unions) use the same exchange rate?

A

The Euro, for example, floats against the US Dollar and the Pound Sterling.

116
Q

What are the four convergence criteria countries have to meet in order to join the Euro?

A
  • Member nations are required to control their government finances, so budget deficits cannot exceed 3% of GDP
  • Gross National Debt has to be below 6% of GDP
  • Inflation has to be below 1.5% of the three lowest inflation countries
  • The average government bond yield has to be below 2% of the yield of the countries with the lowest interest rates. This ensures there can be exchange rate stability.
117
Q

What are the advantages of a currency Union?

A

The participating countries have more currency stability, and the currency is less prone to speculative shocks. This gives future markets more certainty, so there is more investment and growth potential.

There are fewer admin fees and less red tape when travelling abroad or exchanging money.

This also benefits firms which trade with the different member states. It is especially beneficial to small firms, who benefit from the time and money saving of a common currency.

The German monetary credibility might result in all member states having a lower interest rate. This might encourage more investment and spending, which might create more jobs.

118
Q

What are the disadvantages of a currency Union?

A

Labour mobility is limited across Europe due to language barriers. Moreover, the differences in economic performance between member countries means a common monetary policy might not be effective.

The exchange rate is not flexible to meet each country’s need, such as if they need a boost in exports.

Member nations lose sovereignty when there is a common monetary union. This means that countries with a strong economy have to cooperate with countries that have weaker economies. They cannot adapt their policies to meet each individual requirement.

The one-off cost of joining a currency union of changing labels and prices can be significant.

Lack of fiscal policy coordination, lead to high level of government debt. This has built up and lead to countries such as Greece going through a financial crisis.

119
Q

How is reduced ability to use monetary policy and interest rates as tools a disadvantage of Fixed Exchange Rates?

A

Exchange rates can not be changed. So interest can not be changed as it will change the exchange rate.

A-level - Economics Yr13 Mine (7 decks)

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