4.1.8 Exchange rates Flashcards
Exchange rates
The value of one currency in terms of another (£1=€1.80)
Exchange rate systems
Floating exchange rate
Fixed exchange rate
Floating exchange rate
Market determines the value of the currency without government/central bank intervention
Exchange rate is set purely by forces of supply and demand
If there is excess demand for the currency on forex market, then prices rise
This is called an appreciation
Is there is excess supply of the currency on the forex market, prices fall
This is called a depreciation
Fixed exchange rate
Exchange rate is pegged
Occasional realignments (usually a devaluation)
Day-to-day the external value of the currency is usually stable
The central bank negotiates the International Monetary Fund to fix (peg) their currency to another one
A revaluation occurs if the central bank decides to change the peg and increase the strength of its currency
A devaluation occurs if the central bank decided to change the peg and decrease the strength of its currency
Factors influencing Floating Exchange Rates
-Relative interest rates
-Relative inflation rates
-Net investment
-The current account
-Speculation
-Quantitative easing
Impacts of changes in exchange rates
-Depreciation of the pound causes exports to be cheaper for foreigners and imports to the UK are more expensive
-Depreciation that results in an increase in net exports will lead to economic growth
-Cost push inflation is likely to occur as the price of imported raw materials increases with currency depreciation
-If depreciation leads to an increase in exports, unemployment is likely to fall
-Depreciation of a currency makes it cheaper for foreign firms to invest in the country and can increase the FDI
A rising currency
More investment increases demand for the British pound
High interest rates- foreign investors would want money in UK banks
Current account surplus at the balance of payments
Factors affecting value of currency
Trade balances
Foreign direct investment
Portfolio investment
Hot money flows
Currency market analysis
Rise in policy interest rates by Central Bank
Currency more attractive for investors
Attracts inflows of short-term hot money
Causes outward shift on currency demand
Currency appreciates in value in a floating system
The UK Brexit Vote
Brexit vote created fears of recession
Expectation that Bank of England might cut interest rates
Currency traders uncertain about macro prospects of UK
Revaluation
When a country decides to i crease the exchange rate of its currency under a system of fixed exchange rates
