4.1.8 Exchange Rates

Question 1

What is an exchange rate?

Answer 1

The price of one currency relative to another

Question 2

What are the 3 types of exchange rate?

Answer 2

• floating
• fixed
• managed

Question 3

What is a floating exchange rate?

Answer 3

When the value of the exchange rate is determined by demand and supply

Question 4

What are the 3 factors that affect the value of a floating exchange rate?

Answer 4

• interest rates
• relative inflation rate
• speculation

Question 5

How does an interest rate affect the value of a floating exchange rate?

Answer 5

If UK interest rates rise, then the demand for the £ as it is more attractive for foreign consumers and businesses to deposit money in the UK. Therefore demand for sterling will rise from D£1 to D£2, causing an appreciation in the exchange rate.

Question 6

How does inflation affect the value of a floating exchange rate?

Answer 6

If UK inflation is relatively lower than elsewhere, then UK exports will become more competitive and there will be an increase in the demand for sterling to buy British goods. F

Question 7

How does speculation affect the value of a floating exchange rate?

Answer 7

If speculators believe that sterling will appreciate in the future, they will demand more of sterling now to make a profit. Increase in demand will cause an appreciation of the exchange rate. For example, if markets see news of a likley interest rate rise, they will move money into British banks.

Question 8

What is a fixed exchange rate?

Answer 8

A fixed exchange rate has the value determined by the government

Question 9

How does the government change a fixed exchange rate?

Answer 9

The supply of the currency can be manipulated by the central bank, which can buy or sell currency to change the rate to what they want.

Question 10

What is a managed exchange rate?

Answer 10

A managed exchange rate system combines the characteristics of a fixed and floating exchange rate

Question 11

How does the government control a managed exchange rate?

Answer 11

The currency fluctuates due to the free market, but only within a range determined by the central bank. The bank buys and sells its currency to manipulate the supply to influence the e/r.

Question 12

Give an advantage of a managed exchange rate?

Answer 12

Creates a degree of certainty over the maximum price a good might cost

Question 13

What is a appreciation?

Answer 13

When the value of a currency increases.

Question 14

What is a devaluation?

Answer 14

When the value of the exchange rate is officially lowered in a fixed exchange rate system.

Question 15

What is a depreciation?

Answer 15

When the value of one currency falls relative to another currency.

Question 16

What two ways can the government intervene in currency markets?

Answer 16

• currency transactions

- interest rates

Question 17

How can a government use currency transactions to influence an exchange rate?

Answer 17

The government may want a weaker currency to make exports cheaper and imports more expensive. AD e.c.t… . The central bank can release more money into the market which increases the supply of the £ from S£ to S£1.

Question 18

How can a government use interest rates to influence the exchange rate?

Answer 18

The central bank may want a weaker currency. A cut in interest rates will mean foreign consumers and firms will not want their money in British banks, withdrawing it causing the supply of sterling to fall from S£ to S£1

Question 19

Evaluation points of using currency transactions to alter the exchange rate?

Answer 19

-time lag

Question 20

What is the Marshall Lerner Condition?

Answer 20

A depreciation in the exchange rate will improve the condition of the balance of payments so long as the combined PED of the goods and services is greater than -1.

Question 21

According to Marshall Lerner, what happens to the imports if the exchange rate depreciates and the goods and services are inelastic?

Answer 21

The value of Imports will rise

Question 22

According to Marshall Lerner, when exports are PED inelasitc and the currency depreciated, what happens?

Answer 22

The price of exports falls (WPIDEC), total revenue of exports will also fall. Export revenue will then decrease

Question 23

According to Marshall Lerner, when imports are PED inelasitc and the currency depreciated, what happens?

Answer 23

The price of imports rise (WPIDEC), expenditure on imports increases with a weaker exchange rate if imports are inelastic