3.4 Exchange Rates Flashcards
Exchange rates
the value of one currency expressed in terms of another currency
Forex
foreign exchange market where currencies are traded
exchange rate index
expresses one currency against a collection of other currencies
fixed/pegged exchange rates
where the central bank intervenes in the market to ensure that an exchange rate is exactly fixed to a pre-determined value of a currency
revaluation (increase in value)
devaluation (decrease in value)
floating/flexible exchange rate
where the forces of demand and supply determine the price of a currency
Appreciation (increase in value)
depreciation (decrease in value)
managed floating exchange rate
where the currency is able to float within a narrow band of the other currency
app
dep
govt intervenes periodically
Advantages of high exchange rates
downward pressure inflation
more imports can be bought
forces domestic producers to improve their efficiency
disadvantages of high exchange rates
damage to export industries
damage to domestic industries who cannot compete with cheaper foreign goods
unemployment problems if it continues in the longer term
advantages of low exchange rates
greater employments in export industries
greater employments in domestic industries
improves employment
disadvantages of low exchange rates
inflation
competitors may complain
measure to intervene - Why?
lower exchange rate to increase employment
raise exchange rate to fight inflation
maintain fixed exchange rate
avoid fluctuations in a floating exchange rate
achieve relative exchange rate stability to improve business confidence
improve current account deficit
measures to intervene - How?
use reserves of foreign currency to buy/sell own currency
change interest rates
advantages of floating exchange rates
automatic adjustment using forces of demand and supply to return to a stable level
no large foreign exchange reserves required
free to set monetary policy and interest rates for domestic issues
disadvantages of floating exchange rates
uncertainty in business planning, investment, speculation
no discipline required for interest rates
affected by more than just supply and demand - gov’t intervention, world events
may worsen inflation
advantages of fixed exchange rates
certainty and stability - business planning, investment
provides discipline - money supply, interest rates
solves inflationary problems
reduces speculation in the forex market
disadvantages of fixed exchange rates
no automatic adjustment
requires large foreign exchange reserves
monetary policy may be inappropriate
imported inflation
setting the level is too complex
if it is too low (e.g. china) there is international disagreement
problems with overvaluation and undervaluation
factors that affect the flexible exchange rate
demand for goods and services
relatively high/low inflation rates
relatively high/low interest rates
rising/falling real incomes
speculation
foreign reserves buying or selling
factors causing increase in demand for us dollar
increase in us exports of goods/services
increase in foreign investment in us
increase in us interest rates
decrease in us inflation rates
speculative buying of us dollar
us central bank buys dollars (= decrease in foreign reserves)
factors that decrease demand for the us dollar
decrease in us exports
decrease in foreign investment in the us
decrease in us interest rates
increase in us inflation rate
factors that increase supply of the us dollar
increase in us imports
increase in us foreign investment abroad
increase in foreign interest rates
decrease in foreign inflation rate
speculative selling of the us dollar
us central bank sells us dollar (= increase in foreign reserves)
factors that decrease the supply of the us dollar
decrease in us imports
decrease in us foreign investment abroad
decrease in foreign interest rates
increase in foreign inflation rate
factors causing a depreciation
decrease X
economic boom
increase in real income
high inflation
low interest rates
govt selling domestic currency
factors causing an appreciation
increase X
recession
decrease in real income
low inflation
high interest rates
govt buying domestic currency
automatic adjustment
flexible exchange rate will automatically adjust to solve a trade deficit
