4.1.8 Exchange Rates Flashcards
What is a floating exchange rate?
Where the value of the currency is determined purely by market demand and supply of the currency.
However, the central bank can influence the exchange rate indirectly through its monetary policy tools
Includes UK
What is a managed exchange rate?
Where the value of the currency is determined by demand and supply but the centeral bank try to prevent large changes.
I.e Swiss Franc or Japanese Yen
What is a fixed exchange rate?
When a government pegs their currency against another and that exchange rate does not change.
They can revaluate or devaluate the currency against the value of the other if they want to depreciate or appreciate the currency.
For instance, the Hong Kong dollar against the US dollar
What are the factors affecting floating exchange rates?
The interaction of demand and supply.
* The demand for pounds is determined by the amount of British goods that foreigners want to buy (and investment etc).
- The supply of pounds is determined by the amount of foreign goods people in the UK want to buy (and invest, go on holiday etc).
Therefore, it is influenced by the level of exports, imports and the level of investment, those going on holiday and speculation.
How can the government intervene to influence their currency?
Using interest rates -> increase -> people convert money and put in English banks -> demand for £ rise -> appreciates currency. VV.
Use gold and foreign currency reserves -> if value of £ too high -> increase supply by buying foreign foreign currency or gold with £s increasing supply
What is the Marhsall - Lerner condition
States that the sum of the price elasticities of imports and exports must be more than one (i.e elastic) if currency devaluation is to have a positive impact on the trade balance.
Basically, changes wont happen if exports and imports are price elastic.
Explain the J Curve
Shows how the CA will worsen before it improves. People will not immediatly recognise that British exports are cheaper and will take a while to switch. Suppliers also have contracts meaning it takes time for them to switch initally as well.
What would a weaker exchange rate mean for economic growth and unemployment?
A weaker exchange rate is likely to increase exports since they become cheaper and decrease imports so lead to an increase in AD.
What would a weaker exchange rate mean for the rate of inflation?
Could cause cost push inflation if imports become more expensive from a devalued currency. AD could also increase causing demand pull inflation if domestic suppliers cannot catch up.
What would a weaker exchange rate mean for FDI?
A fall in currency may increase FDI because it becomes cheaper to invest. However, if currency falls too much it is an indication that an economy has serious problems which will discourage investment.
