4.1.8 Exchange Rates

Question 1

What are the different exchange rate systems?

Answer 1

• managed
• fixed
• floating

Question 2

What is a managed exchange rate?

Answer 2

• when the govt intervenes to manipulate the value of the exchange rate
• the aim is to avoid volatility of the exchange rate, promote stability + lower inflation
• thereby providing a better environment for investment + economic growth

Question 3

How does a managed exchange rate get lowered?

Answer 3

• if the govt wants to lower the exchange rate they sell that currency and/or lowers interest rates

Question 4

How does a managed exchange rate get increased?

Answer 4

• if they want to increase the exchange rate they buy more of that currency with foreign exchange reserves
• and/or they may increase interest rates

Question 5

How does a managed exchange rate assist LEDCs?

Answer 5

• LEDC might seek to depreciates their currency
• this helps exports to be more price competitive so net exports improve
• this may encourage investment which is crucial for growth + development

Question 6

How can a managed exchange rate assist development + economic growth?

Answer 6

• if country/central bank might seek to lower the exchange rate = export prices cheaper + imports more expensive
• increased demand for exports, fall in demand for imports = improved trade balance
• (X-M) increases = AD increases = rightward shift
• increase in real GDP, fall in unemployment + inflationary pressures