4.1.8 exchange rates

Question 1

characteristics of a floating exchange rate

Answer 1

currency value is set by the market - speculation causes change in floating exchange rate

no government intervention - no target

Question 2

advantages of a floating exchange rate

Answer 2

reduces the need to hold large foreign currency reserves

freedom to set interest rates

automatic correction

less risk

Question 3

disadvantages of a floating exchange rate

Answer 3

can be volatile - reduces FDI

a lower, more competitive exchange rate does not guarantee a current account surplus

Question 4

definition of a fixed exchange rate

Answer 4

government fixes currency value to another currency - central bank must hold sufficient currency reserves

Question 5

advantages of a fixed exchange rate

Answer 5

stability - attracts FDI and controls inflation

lower borrowing costs

less speculation

Question 6

disadvantages of a fixed exchange rate

Answer 6

cannot use interest rates in macro policies (monetary policy)

developing countries may not have sufficient foreign currency reserves to fix

devaluation of exchange rate leads to cost-push inflation

Question 7

characteristics of a managed exchange rate

Answer 7

currency value set by market forces

central bank occasionally intervenes

currency is a key target of monetary policy

Question 8

competitive devaluation intentions

Answer 8

makes exports cheaper and imports more expensive

increases growth

increases inflation

improved current account

Question 9

definition of revaluation

Answer 9

when the value of the currency is adjusted

Question 10

definition of appreciation

Answer 10

when the value of the currency increases

Question 11

definition of devaluation

Answer 11

when the value of the currency is lowered in a fixed exchange rate system

Question 12

definition of depreciation

Answer 12

when the value of the currency falls

Question 13

factors influencing exchange rates

Answer 13

inflation

other currencies

government finances

balance of payments

international competitiveness

Question 14

government intervention in the currency markets - interest rates (hot money flows)

Answer 14

an increase in interest rates is more attractive for foreign investors

this increases demand for currency, appreciating the value of the currency

Question 15

government intervention in the currency markets - quantitative easing

Answer 15

increases supply of money and depreciates currency

Question 16

government intervention in currency markets - foreign currency transactions

Answer 16

buying and selling foreign currency to manipulate domestic currency