4.1.8 Exchange rates

Question 1

what is an exchange rate?

Answer 1

the rate at which one country’s currency can be exchanged for other currencies in the foreign exchange market

Question 2

what are the main exchange rate systems?

Answer 2

• free floating currency
• a managed floating currency
• a fixed exchange rate

Question 3

what’s a free floating currency?

Answer 3

the external value of a currency depends on market forces of supply and demand

Question 4

what’s a managed floating currency?

Answer 4

when the central bank may choose to intervene in foreign exchange market to affect the value of a currency to met macro economic demands

Question 5

what’s a fixed exchange rate system?

Answer 5

a currency’s value is fixed or pegged by a monetary authority against the value of another currency eg gold

Question 6

what’s depreciation?

Answer 6

fall in a floating exchange rate system (WIDEC)
weak currency imports dear exports cheaper

Question 7

whats devaluation?

Answer 7

fall in a fixed system

Question 8

whats appreciation?

Answer 8

rise in a floating system (SPICED)
Strong pounds,imports cheap, exports dear

Question 9

whats revaluation?

Answer 9

rise in a fixed system

Question 10

components of free floating exchange rate?

Answer 10

• external value is set by market forces
• no intervention
• no target for the exchange rate

Question 11

what factors cause change in the floating exchange rate?

Answer 11

• trade balances, countries have strong trade + CA surpluses ➡️ curriences appreciate as money flows into
• FDI
• portfolio investment, strong inflows of investment ➡️ currency to appreciate
• interest rate differentials
• speculation

Question 12

components of managed exchange rates?

Answer 12

• currency is set by market forces
• a central bank may intervene occasionally to influence the price
• the currency becomes a target of monetary policy

Question 13

how are floating exchange rates managed?

Answer 13

• changes in monetary policy interest rates
• quantitative easing
• direct buying and selling
• taxation of overseas currency deposits and capital controls

Question 14

why do countries have competitive devaluations ( deliberately intervening to drive down the value of their currency) ?

Answer 14

• to provide a competitive lift to demand, output and jobs in their export industries
• attract FDI
  but
• can be seen as a form of protectionism

Question 15

components of a fixed exchange rate?

Answer 15

• the govt fixed the currency value
• pegged exchange rate

Question 16

whats the impact of a currency depreciation?

Answer 16

• export prices fall
• import prices rise
  ✅
• AD increases
• increase in employment in exporting and domestic industries
  ❌
• higher inflation

Question 17

whats the impact of a currency appreciation?

Answer 17

✅
- lower inflation
- cheaper imports
- efficiency gains for domestic products
❌
- lower growth
- high unemployment in exporting/domestic industries