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Armstrong > 4.1 (8-9) > Flashcards

4.1 (8-9) Flashcards

1
Q

The impact of a fall in the currency on the current account of BOP

A

-spike in GDP generated exports if can outweigh other countries
-decrease in imports
- increase in exports

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2
Q

The impact of a fall in the currency on the economic growth and employment

A

-possible increase in employment, as increase in demand
-tourism brings in money

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3
Q

The impact of a fall in the currency on inflation

A

-increase in exports leads to inflation
-cost of living becomes more expensive

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4
Q

The impact of a fall in the currency on FDI

A

-increase as it is an incentive as it is cheaper to invest in the uk economy

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5
Q

Depreciation in the exchange rate

A

-tends to increase rate of economic growth and reduce unemployment
-tends to benefit exporters, but makes import more expensive
-tends to cause inflation because :
* imports more expensive
* higher domestic demand
* firms have less incentive to cut costs
-tends to improve the current account deficit

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6
Q

Effect of an exchange rate depreciation on the BOP

A

Value of exports will increase: because they are now cheaper to buy for foreign consumers so they will increase total spending on exports

Value of imports will fall: as they are more expensive for domestic consumers so they will decrease spending on imports

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7
Q

What is international competitiveness

A

-the degreee to which a country can compete in international markets, while simultaneously maintaining and expanding the real incomes of its citizens

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8
Q

price competitive

A

-how cheaply a country can produce a good or service

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9
Q

Non-price competitive

A

product quality, innovation, design, reliability and performance

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10
Q

ways to measure competitiveness

A

-relative export prices
-productivity

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11
Q

relative export prices (as a way to measure competitiveness)

A

-this is the ratio of one countries export prices relative to another country, and it is expressed as an index. the lower the relative export price, the more competitive the country

To be competitive a country will need:
* exchange rates to devalue overtime
* inflation rates to be lower than those of other countries

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12
Q

productivity (as a way to measure competitiveness)

A

-productivity is a measure of output per input. The most common measure would be labour productivity
-the unit labour cost is how much labour costs per unit of output

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13
Q

Unit labour costs are

A

measure the labour costs per unit of output. It compares the average output per hour to the wages paid labour costs/output

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14
Q

union labour costs increases if

A

-wage costs rise relatively faster
-labour productivity is weaker than other countries

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15
Q

4 factors influencing competitiveness

A

-infrastructure (transport, communication, internet speed etc)
-gov efficiencies (property rights, laws, corruption etc)
-business efficiency ( degree of competition, productivity, quality etc)
-economic performance (inflation, debt, growth etc)

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16
Q

Ways to improve price competitiveness

A

-reducing wage costs
-improving productivity
-reducing other costs
e.g. health, safety, environmental costs

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17
Q

ways to improve non-price competitiveness

A

Improved technical factors
e.g. product quality, design, reliability, performance choice, after sales service, marketing, branding

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18
Q

policies to improve competitiveness

A

-improve labour markets
* improved education and training
* improved management skills

-infrastructure investment
* better motorways, airports, hi-speed rail
* improved broadband

-Macro-economic stability
* low inflation, price stability
* competitive exchange rate

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19
Q

An exchange rate is

A

An exchange rate is the rate at which one country’s currency can be exchanged for other currencies in the foreign exchange (FX) market.

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20
Q

Effective exchange rate

A

This is a weighted index of sterling’s value against a basket of currencies
The weights are based on the importance of trade between the UK and each country.

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21
Q

What are the main exchange rate systems?

A

-A free-floating currency
-A managed-floating currency
-A fixed exchange rate system

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22
Q

A free-floating currency

A

where the external value of a currency depends on market forces of supply and demand – there is no central bank intervention

  • The external value of the currency is set by market forces
  • There is no intervention by the central bank
  • There is no target for the exchange rate
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23
Q

A managed-floating currency

A

A managed-floating currency when the central bank may choose to intervene in the foreign exchange markets to affect the value of a currency to meet specific macroeconomic objectives

  • Currency is usually set by market forces
    -A central bank may intervene occasionally to influence the price
    -In a managed floating system, the currency becomes a key target of monetary policy
24
Q

A fixed exchange rate system

A

A fixed exchange rate system e.g. a hard currency peg either as part of a currency board system or
membership of the ERM Mark II for those EU countries eventually intending to join the Euro.

-The government / central bank fixes the currency value
-Pegged exchange rate becomes official rate
-Adjustable peg

25
Q
  • Depreciation
  • Devaluation
  • Appreciation
  • Revaluation
A
  • Depreciation is a fall in the value of a currency in a floating exchange rate system
  • Devaluation is a fall in the value of a currency in a fixed exchange rate system
  • Appreciation is a rise in the value of a currency in a floating exchange rate system
  • Revaluation is a rise in the value of a currency in a fixed exchange rate system
26
Q

What factors cause changes in the currency in a floating system?

A
  1. Trade balances – countries that have strong trade and current account surpluses tend to see their currencies appreciate as money flows into the circular flow from exports of goods and services and from investment income
  2. Foreign direct investment (FDI) – an economy that attracts high net inflows of capital investment from overseas will see an increase in currency demand and a rising exchange rate.
  3. Portfolio investment – strong inflows of portfolio investment into equities and bonds from overseas can cause a currency to appreciate
  4. Interest rate differentials - countries with relatively high interest rates can expect to see ‘hot money”/short- term capital flowing coming in and causing an appreciation of the exchange rate.
  5. Speculation – this is responsible for much of the day-to-day volatility
27
Q

Policy Tools for Managing Floating Exchange Rates

A
  • Changes in monetary policy interest rates
    -Changes in interest rates e.g. lower interest rates to depreciate the exchange rate
    -Causes movements of “hot money” banking flows into or out of a country
  • Quantitative easing
    -Increase liquidity in the banking system leading to lower interest rates, usually causes outflow of
    money – depreciation of the exchange rate
  • Direct buying / selling in the currency market (intervention)
    -Direct intervention in the currency market
    -Buying and selling of domestic / foreign currencies
  • Taxation of overseas currency deposits and capital controls
    -Taxation of foreign deposits in banks cut the profit from hot money inflows
    -Controls on the free flow of capital into and out of a country
28
Q

Competitive Devaluations / Dirty Floating

A
  • Competitive devaluations occur when a country deliberately intervenes to drive down the value of their currency to provide a competitive lift to demand, output and jobs in their export industries.
29
Q

Ways Exchange Rates Impact Business Activity

A
  1. Price of exports in international markets
  2. Cost of goods bought from overseas
  3. Revenues and profits earned overseas
  4. Converting cash receipts from customers overseas
30
Q

Winners from low exchange rate

A

-Businesses exporting into international markets
-Businesses earning substantial profits in overseas
currencies

31
Q

Losers from low exchange rate

A

-Businesses importing goods and services
-Overseas businesses trying to compete in the domestic market

32
Q

Impact of a currency depreciation

A
  • A currency depreciation usually has a similar effect on the macro-economy as a cut in interest rates
  • A currency depreciation may help to provide a partial auto-correction of a large trade deficit.
33
Q

Evaluating Effects of a Currency Depreciation

A

Depreciation of the exchange rate provides stimulates aggregate demand but this depends on:
1. The variable length of time lags as consumers and businesses respond
2. The scale of any change in the exchange rate i.e. a 5%, 10%, 20%
3. Whether the change in a currency is temporary or longer-lasting
4. The coefficients of price elasticity of demand for X&M
5. The size of any second-round multiplier and accelerator effects
6. When the currency movement takes place – i.e. Which stage of an economic cycle (recession, recovery etc.)
7. The type of economy (e.g. the impact will be different for small developing nations v large advanced countries)
8. The degree of openness of the economy to international trade i.e. measured by the value of trade as a % of GDP

34
Q

Advantages of Floating Exchange Rates

A

-Reduces the need for a central bank to hold large amounts of currency reserves
-Freedom to set monetary policy interest rates to meet domestic objectives
-May help to prevent imported inflation
-Insulation for an economy after an external shock especially for export-dependent countries
-Partial automatic correction for a current account deficit
-Less risk of a currency becoming significantly over/undervalued

35
Q

Dis / evaluation of Floating Exchange Rates

A

-No guarantee that floating exchange rates will be stable
-Volatility in a floating currency might be detrimental to attracting inward investment
-A lower (more competitive) exchange rate does not necessarily correct a persistent balance of payments deficit - consider the J curve theory and also the importance of non-price competitiveness

36
Q

Advantages of Fixed Exchange Rates

A

-Certainty of currency value gives confidence for inward investment from overseas businesses
-Reduced costs of “currency hedging” for businesses such as airlines
-Currency stability helps to control inflation – i.e. it is a discipline on businesses to keep labour costs
low
-A stable currency can lead to lower borrowing costs (i.e. lower yields on government bonds)
-Imposes responsibility on government macro policies e.g. to keep inflation under control
-Less speculation in the currency market if the fixed exchange rate is regarded by traders as credible

37
Q

Dis / evaluation of Fixed Exchange Rates

A

-Reduced freedom to use interest rates for other macro objectives such as stimulating GDP growth
-Many developing countries do not have sufficient foreign currency reserves to maintain a fixed
exchange rate
-Difficult for countries to use a competitive devaluation of their fixed exchange rate – this creates political tensions and might lead to a protectionist response
-Devaluation of a fixed exchange rate can lead to a surge in cost-push inflation – this is damaging for
competitiveness and has regressive effects on poorer families

38
Q

Floating versus Fixed Exchange Rates

A
  • Fixed rates may be optimal for developing countries wanting to control inflation
  • Export-dependent economies may favour a managed floating rate e.g. to offset fluctuating world prices
  • Not every country has the reserves to influence currency
  • Choice of currency regime is hugely important for developing countries. Some countries have opted to join a monetary union e.g. the nineteen members of the Euro Zone.
39
Q

What is competitiveness?

A

External competitiveness is the sustained ability to sell goods and services profitably at competitive prices overseas.

40
Q

Price (or cost) competitivenes

A
  • Key measure: Differences in relative unit labour costs (ULCs)
41
Q

Non-price competitiveness

A

Non-price competitiveness
* Key aspects: Product quality, innovation, design, reliability and performance, choice, after-sales services, marketing, branding, brand loyalty and the availability and cost of replacement parts

42
Q

Non-wage cost factors include:

A
  1. Environmental taxes e.g. minimum prices on carbon emissions
  2. Employment protection laws & health and safety regulations
  3. Statutory requirements for employer pensions
  4. Employment taxes e.g. employers’ national insurance costs
43
Q

Unit labour costs are

-equation
-Determined by

A

Unit labour costs are labour costs per unit of output. There is a simple formula for calculating unit labour costs:

Unit labour costs = total labour costs / total output

Unit labour costs are determined mainly by:
1. Average wages / salaries in a country’s labour market – one measure tracked is the hourly labour cost of
employing people in the labour market
2. Labour productivity i.e. output per person employed or output per hour worked

Key analysis point: Unit labour costs will tend to rise when wages are rising faster than productivity

44
Q

How to lower Relative Unit Labour Costs

A
  • Relative unit labour costs will rise when
    -A country’s exchange rate appreciates
    -Wage costs rise relatively faster than other nations
    -Labour productivity growth is relatively slower
  • Options for reducing relative unit labour costs
    -Monetary policy interventions aimed at a currency depreciation e.g. a managed floating exchange rate
    -Wage controls e.g. wage/pay freezes in the public sector
    -Supply-side measures designed to raise labour productivity / efficiency across many industries
45
Q

Relative export prices are

A

Relative export prices are one country’s export prices in relation to other countries, usually expressed as an index.

46
Q

Relative export prices will rise when

A
  1. There is an appreciation of the currency – causing export prices in overseas markets to rise
  2. There is a period of high relative inflation in one country compared to others – again this tends to make exports appear more expensive when priced in an overseas currency
  3. When export businesses experience higher costs e.g. arising from environmental taxes, increased minimum wages which leads them to raise price to protect their profit margins
  4. When exporters of goods and services are hit by import tariffs
47
Q

Policies to improve competitiveness

A
  1. Competitive exchange rate – perhaps involving a managed floating currency
  2. Competitive tax environment to attract inward investment and encourage new business start-up’s
  3. Investment in human capital to improve the quality of the workforce
  4. Increased research & development to drive a faster pace of innovation
  5. Stronger market competition to raise factor productivity and lower relative export prices
  6. Stable macroeconomic environment e.g. maintaining low inflation with steady economic growth to support
    business confidence
  7. Investment in critical infrastructure such as better road, air and rail links, improved ports, faster broadband
    and fibre-optic internet connections

Competitiveness is strongly affected by the pace of innovation in different markets and industries.

48
Q

Fiscal policy and international competitiveness

A
  1. Subsidies to lower the cost of research e.g. in pharmaceuticals, life sciences, robotics and artificial intelligence
  2. Tax incentives can encourage the commercialisation of ideas e.g. ideas coming out of universities
  3. Lower employment taxes to stimulate skilled migration from overseas
  4. Lower capital gains taxes encourage small businesses / start-ups
  5. Special economic zones (SEZ) to attract research-intensive businesses
49
Q

What matters for competitiveness in the long run?

A
  • Macro competitiveness has micro foundations
    -Competitive markets and innovative businesses
    -Skills, aptitudes and attitudes within a diverse workforce
    -Expanding opportunities for female entrepreneurs /refugees
  • Recognition that infrastructure and innovation are crucial: increasingly, competitiveness flows from smart urbanization
  • Competitive advantage comes from having
    -Globally scaled businesses close to or at the technological frontier
    -A culture of innovative business start-ups / social entrepreneurs
    -A financial system that can provide appropriate and affordable credit for education, business research and funding for business expansion
  • Reliance on currency depreciation / devaluation and wage cuts is not a sustainable competitiveness strategy
    -The most competitive countries have the highest minimum wages
    -There is a continuous global battle for the most talented workers
    -Races to the bottom” e.g. in taxes and wages have a limited impact
50
Q

benefits of International Competitiveness

A

-Improved living standards e.g. measured by real GNI per capita (PPP)
-Stronger trade performance from an increase in export sales
-Virtuous circle of economic growth
-Employment creation
-Higher government tax revenues

51
Q

Dis of International Competitiveness

A

-Trade surpluses might invite a protectionist response
-Possible risks of demand-pull inflation
-Competitiveness might be achieved at the expense of growing inequality of income and wealth
-Higher productivity might be achieved at expense of a worsening work-life balance and increased incidence of mental health problems
-Increased competitiveness might cause a country’s exchange rate to appreciate

52
Q

What is an internal devaluation?

A
  • Internal devaluation happens when a country seeks to improve price competitiveness through lowering their wage costs and increasing productivity and not reducing the external value of their exchange rate.
  • Internal devaluation is more likely to happen with a country that has a fixed exchange rate
53
Q

What is an external devaluation?

A
  • An external devaluation happens when a country operating with a fixed or semi-fixed exchange rate system decides to deliberately lower the external value of their currency against one or arrange of other currencies.
  • A devaluation of the currency means a domestic currency buys less of a foreign currency.
  • Linked aims might include reducing the size of a trade deficit and also to cut the real value of sovereign. Debt owed to international creditors. In theory, currency devaluation is a fast way of improving price competitiveness than an internal devaluation.
54
Q

Evaluation: Risks from an internal devaluation:

A
  1. Severe loss of output and rising unemployment
  2. Fall in nominal wages reduces living standards
  3. Risks from sustained price deflation
  4. Real value of debt increases
  5. Danger of a country suffering a permanent loss of output (known as “hysteresis”)
55
Q

Drawbacks from an external devaluation:

A
  1. Increase in cost-push inflation from higher import prices
  2. Reduces real incomes because of a rise in inflation
  3. No guarantee that the trade deficit will improve (refer to the J Curve concept)
  4. Foreign creditors will demand higher interest rates on new issues of government & corporate debt
  5. Currency uncertainty makes country less attractive to inward FDI,
56
Q

A devaluation of the currency means

A

A devaluation of the currency means a domestic currency buys less of a foreign currency

Armstrong (11 decks)

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