4.1.8- exchange rates

Question 1

What is an exchange rate?

Answer 1

The weight of one currency relative to another.

Question 2

What are the 3 types of exchange rates?

Answer 2

• floating
• fixed
• managed

Question 3

What is a floating exchange rate?

Answer 3

The value of the exchange rate is determined by the forces of supply and demand.

• when demand increases, the exchange rate appreciates
• the demand for currency= exports plus capital inflows.
• the supply of currency= imports plus capital outflows.

Question 4

What is a fixed exchange rate?

Answer 4

value determined by the government compared to other currencies.
The country can decide to devalue its currency to improve competitiveness.

Question 5

What is a managed exchange rate?

Answer 5

The currency fluctuates, but it doesn’t float fully on a free market.
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, to try prevent large changes.

• also by manipulating interest rates.

Question 6

What is distinction between revaluation and appreciation?

Answer 6

revaluation= currency increases against the value of another fixed system.

appreciation= increase of value using floating exchange rates.

Question 7

What is distinction between devaluation and depreciation?

Answer 7

devaluation= value of a currency is officially lowered in a fixed exchange rate system

depreciation= value of a currency falls relative to another currency, in a floating exchange rate system.

Question 8

What factors influence floating exchange rates?

Answer 8

• inflation
• speculation
• other currencies
• government finances
• balance of payments
• international competitiveness

Question 9

How does inflation influence?

Answer 9

lower inflation means exports are relatively more competitive.
Increases the demand for the currency
Causes currency to appreciate

Question 10

How does speculation influence?

Answer 10

if speculators think a currency will appreciate in the future, demand will increase in the present, since they believe a profit can be made by selling the currency in the future.

This causes an increase in value of currency

Question 11

How do other currencies influence?

Answer 11

if markets are concerned about major economies, the currency might rise.

Question 12

How does gov finances influence?

Answer 12

a gov with high level of debt is at risk of defaulting.
could cause currency to depreciate, since investors start to lose confidence in the economy.

Question 13

How does balance of payments influence

Answer 13

when the value of imports exceeds exports, current account deficit.
countries which struggle to finance this have currencies which depreciate as a result.

Question 14

How does intern compet influence?

Answer 14

• an increase in competitiveness increases demand for exports, which increases demand for the currency.
• this causes an appreciation of the currency.

Question 15

What methods do governments use to influence the value of their country?

Answer 15

• interest rates
• QE
  -foreign currency reserves

Question 16

How do interest rates influence the value?

Answer 16

An increase in int rates will strengthen the pound as people will put their money in english banks because the rate of investment is higher, so demand for the pound will rise.
This will cause an appreciation.
This is known as hot money.

Question 17

How does quantitative easing influence the value?

Answer 17

• helps to stimulate the economy.
• this can be inflationary as it increases the money supply, can reduce the value of the currency.

Question 18

How does foreign currency reserves manipulate the value of their currency?

Answer 18

• if the value of the pound is too high and they want to weaken it, they can increase supply by buying foreign currency or gold with pounds.
• to strengthen the pound, they can increase demand by selling their foreign currency or gold in exchange for pounds.

HOWEVER= little impacts on long term.

Question 19

What are the consequences of competitive devaluation/ depreciation?

Answer 19

• a weaker currency, encourages exports and discourages imports and so balance of payments should improve.
  HOWEVER- it can cause inflation due to the higher costs of imports and demand pull inflation due to increase in AD
• and this may reduce competitiveness, leading to a fall in the balance of payments.
• other countries may follow and reduce their currency as well.
• also depends on PED, inelastic exports will not increase significantly if price falls.

Question 20

What are the 4 impacts of exchanges in exchange rates?

Answer 20

• the current account (Marshall- Lerner condition and J curve effect)
• economic growth and employment/unemployment
• rate of inflation
• FDI flows