4.1.8 - Exchange Rates

Question 1

What Is An Exchange Rate?

Answer 1

Price of one currency, in terms of another.

Question 2

If There Is Increased Supply For A Currency, What Happens?

Answer 2

The currency gets weaker.

Question 3

If There Is Decreased Supply For A Currency, What Happens?

Answer 3

The currency gets stronger.

Question 4

If There Is Increased Demand For A Currency, What Happens?

Answer 4

The currency gets stronger.

Question 5

If There Is Decreased Demand For A Currency, What Happens?

Answer 5

The currency gets weaker.

Question 6

What Are Factors That Influence The Exchange Rate?
(6 Points)

Answer 6

~ Imports and exports.

~ Speculation.

~ Relative interest rates.

~ Relative inflation rates.

~ FDI.

~ Quantitative easing.

Question 7

Describe ‘Imports & Exports’ As A Factor Influencing The Exchange Rate
(2 Points)

Answer 7

~ Less import spending, means less supply of the currency, causing it to get stronger. Vice versa.

~ Less export spending, means less demand of the currency, causing it to get weaker. Vice versa.

Question 8

Describe ‘Speculation’ As A Factor Influencing The Exchange Rate
(2 Points)

Answer 8

~ Speculation of the currency appreciating, means more demand for the currency now, causing an appreciation now. Vice versa.

~ Speculation of the currency depreciating, means more supply of the currency now, causing a depreciation now. Vice versa.

Question 9

Describe ‘Relative Interest Rates’ As A Factor Influencing The Exchange Rate
(2 Points)

Answer 9

~ Higher interest rates, means increased flow of hot money, increasing the demand for the currency, causing an appreciation.

~ Lower interest rates, means decreased flow of hot money, increasing the supply for the currency, causing a depreciation.

Question 10

Describe ‘Relative Inflation Rates’ As A Factor Influencing The Exchange Rate
(2 Points)

Answer 10

~ Higher inflation rate, means higher prices, means less exports, decreasing the demand for a currency, causing a depreciation.

~ Lower inflation rate, means lower prices, means more exports, increasing the demand for the currency, causing an appreciation.

Question 11

Describe ‘FDI’ As A Factor Influencing The Exchange Rate
(2 Points)

Answer 11

~ Increased FDI, means more demand for the currency, causing an appreciation.

~ Decreased FDI, means less demand for the currency, causing a depreciation.

Question 12

Describe ‘Quantitive Easing’ As A Factor Influencing The Exchange Rate

Answer 12

QE, increases the supply of a currency, causing a depreciation.

Question 13

What Areas Of An Economy, Do Changes In Exchange Rates Affect?
(4 Points)

Answer 13

~ Growth and employment.

~ Inflation rate.

~ FDI flows.

~ Current account.

Question 14

Describe ‘Growth & Employment’ As An Area Of The Economy Affected By Exchange Rate Changes
(4 Points)

Answer 14

~ Depreciation, means export expenditure increases, increasing AD and growth, meaning increased employment.

~ But, causes more expensive imports, meaning rising costs of production, meaning higher prices, lower growth and lower employment.

~ Appreciation, means export expenditure decreases, decreasing AD and growth, meaning decreased employment.

~ But, causes cheaper imports, meaning lower costs, meaning lower prices, higher growth and higher employment.

Question 15

Describe ‘Inflation Rate’ As An Area Of The Economy Affected By Exchange Rate Changes
(2 Points)

Answer 15

~ Depreciation, means export expenditure increases, increasing AD and growth, leading to demand-pull inflation and cost-push inflation.

~ Appreciation, means export expenditure decreases, decreasing AD and growth, leading to lower inflation.

Question 16

Describe ‘Current Account’ As An Area Of The Economy Affected By Exchange Rate Changes
(2 Points)

Answer 16

~ Depreciation, means exports > imports, improving the current account balance.

~ Appreciation, means imports > exports, worsening the current account balance.

Question 17

Describe ‘FDI Flows’ As An Area Of The Economy Affected By Exchange Rate Changes
(2 Points)

Answer 17

~ Depreciation, means FDI would be cheaper, increasing FDI flows.

~ Appreciation, means FDI would be more expensive, decreasing FDI flows.

Question 18

In The Short-Run, What Elasticity Is Imports & Why?
(3 Points)

Answer 18

~ Import demand is inelastic.

~ As importers, can’t immediately respond to changes in exchange rate.

~ Increasing import expenditure, worsening the current account balance.

Question 19

In The Long-Run, What Elasticity Is Imports & Why?
(3 Points)

Answer 19

~ Import demand is elastic.

~ As importers, are able to respond to changes in exchange rate.

~ Decreasing import expenditure, improving the current account balance.

Question 20

What Does The J-Curve State?

Answer 20

The impact of changing exchange rates on the current account, changes between the SR and the LR.

Question 21

Draw & Explain The J-Curve
(2 Points)

Answer 21

~ Following a currency depreciation, in the SR import demand is inelastic, as importers aren’t able to respond to changes in exchange rates.

~ In the LR, import demand is elastic, as the marshall-lerner condition has been satisfied, imports demand become elastic, improve the current account balance.

Question 22

What Does The Marshall-Lerner Condition State?
(2 Points)

Answer 22

~ PED for exports + PED for imports > 1.

~ Needs to met, before an economy’s current account deficit will improve, following a depreciation.

Question 23

What Is The Marshall-Lerner Condition, In The SR?

Answer 23

PED for exports + PED for imports < 1.

Question 24

What Is The Marshall-Lerner Condition, In The LR?

Answer 24

PED for exports + PED for imports > 1.

Question 25

What Are The Ways, In Which A Country Can Manage Its Exchange Rate? (2 Points)

Answer 25

~ Changing interest rates. ~ Foreign currency transactions.

Question 26

Describe 'Changing Interest Rates' As A Way To Manage An Exchange Rate (2 Points)

Answer 26

~ Increasing I.R, increases hot money flows, increasing demand for the currency, causing an appreciation. ~ Decreasing I.R, decreases hot money flows, increasing supply for the currency, causing a depreciation.

Question 27

Describe 'Foreign Currency Transactions' As A Way To Manage An Exchange Rate (2 Points)

Answer 27

~ Selling its own currency, increases supply for the currency, causing a depreciation. ~ Selling foreign currency for its own currency, increases demand for the currency, causing an appreciation.

Question 28

What Is Competitive Depreciation / Devaluation?

Answer 28

Depreciation your own currency, to reap the benefits and become more competitive.

Question 29

What Are The Consequences Of Competitive Depreciation / Devaluation? (3 Points)

Answer 29

~ Retaliation, leading to a currency war. ~ Causing imports to become expensive. ~ E.g. China and Thailand.

Question 30

What Are The Different Exchange Rate Systems? (3 Points)

Answer 30

~ Floating. ~ Fixed. ~ Managed.

Question 31

What Are 'Fixed' Exchange Rates?

Answer 31

When a government fixes their currency, against another country's.

Question 31

How Does A Government 'Fix' An Exchange Rate? (2 Points)

Answer 31

~ Changing interest rates. ~ Using foreign currency transactions.

Question 32

What Is Meant By 'Revaluation'?

Answer 32

Increasing the value of fixed exchange rates.

Question 32

What Is Meant By 'Devaluation'?

Answer 32

Decreasing the value of fixed exchange rates.

Question 33

What Are 'Managed' Exchange Rates? (2 Points)

Answer 33

~ Keeps the value of the currency, within a specific range. ~ Government or central bank, will only intervene, if the currency goes above or below this range.

Question 34

What Are 'Floating' Exchange Rates? (2 Points)

Answer 34

~ Exchange rate, is determined by the supply and demand for a domestic currency. ~ Government does not intervene at all.