4.2.6 International economy Flashcards
define floating exchange rates
an exchange rate that is affected by market forces, ie the demand and supply of the currency
list 5 advantages of a floating exchange rate (explain them)
- Monetary policy autonomy. allows for greater flexibility in conducting independent monetary policy, so can focus on domestic issues.
- shock absorption. can absorb external shocks more easily. e.g recession causing exchange rate to depreciate leading to exports becoming more competitive, providing income for business
- reduced speculation. rate determined by market so speculative attacks not worthwile and wouldnt cause a mjor financial gain
- currency reserves. central banks not required to hold large reserves as there is no currency target. financial capital can flow freely accross countries seeking the best returns.
- trade balence adjustment. as deficit grows, currency depreciates until export can become price competitive and help decrease the deficit
list 4 disadvantages of a floating exchange rate (explain them)
- volatility. potential for extreme volatility and experteince large fluctuations, creating uncertainty for businesses engaged in international trade and investment.
- currency risk.volatility creates currency risk for investors + businesses
- inflation pass-through.exchange rate changes lead to changes in import prices, which can impact domestic inflation. significant depreciation can contribute to imported inflation and erode real purchasing power.
- loss of exchnage rate as a policy tool. lose ability to manage exchange rate as a delibaerate polocy tool. limits influence of exchnage rates on trade and competitivesness
define a fixed exchange rate
the currency is pegged to another country’s currency or to a commodity of a good (many currencies pegged to dollar such as Saudia Arabria and Hong Kong)
state and explain 4 advantages of a fixed exchange rate
- price stability. fluctuations of rate are minimised. stability can help control inflation and proviide predicatbale for environment for businesses and consumers
- trade confidence. businesses can plan for transactions without worrying about sudden rate changes, international trade more predictable
- reduced exchange rate risk. eliminate currency risk associated with fluctuating exchange rate
- foreign investment. a stable exchnage rate can attract foreign investment, as is more predictable
state and explain 5 disadvantages of fixed exchange rates
- lack of flexibility. lack of flexibility to external shocks. countries cannot adjust exchange rates independently to address changing economic conditions
- loss of monetary policy autonomy country may be forced to adopt monetary policies that aren’t suited for its circumstances
- BoP issues. BoP must be maintained through other mens like fiscal policy or controls on capital flows. imbalences can lead to pressures on the currency peg.
- speculative attacks. if investors belive it is overvalued invetsors can attack currency if concerns arise of country’s ability to maintain peg.
- dependence on reserves. to maintain fixed rate, country needs sufficeint forex reserves. if reserves are low, country might struggle to defend the peg during times of market stress
what is a speculative attack?
speculators aggresively trade a nation’s currency anticipating its depreciation in the near future. normally in fixed systems and can trigger mass selling of assets by large financial institutions.
what are the 5 advantages of being in a monetary union
- cheaper cross border trade. currency conversion is eliminated
- membership likely to stimulate inward investment. (tourism, financial services etc)
- increase price contestability. single currency helps consumers find prodcuts at better prices
- eliminates costly conversion of money. might improve labour mobility
- group currency more stable. redcued currency risk makes borrowing even in smaller countries easier.
what are the 5 disadvantages of being in a monetary union
- can’t use exchange rate as a monetary policy tool. may have to experience an internal devaluation
- interest rate set for monetary union, not single country. interest rates not often “one size fits all”
- joint interest rate may cause divergence of living standards. as different countries will be in different parts of the cycle
- integration leads to risks. if another country in union enters recession has a signifcant effect on you
- membership might expose a government to the financial costs of furture bail-outs of struggling countries
what is a managed floating exchange rate
it is a floating exchange rate that allows for a central bank to intervene regularly in forex markets to change the firection of the currency’s float
why might a central bank intervene in a floating exchange rate
depreciation:
* improve balence of trade or improve current account by making exports more price competitive
* reduce the risk of deflationary recession as a lower rate increases export demand and increases domestic price levvel
* rebalanceing the economy towards more capital investment and more exports
appreciation:
* stop demand pull inflationary pressures
* reduce prices of imported capital and technology
what are the limits to central bank intervention to manage a currency’s value
- requires large forex reserves, many smaller countries won’t have these
- central banks may not be strong enough to intervene comapred to sheer weight of speculative buying and selling in global currency markets (forex markets turnover $6 trilliong a day)
- changing interest rates to influence a currency might conflict agasint other macro objectives
what are the advantages of protectionism
- infant industries might be able to grow enough to compete internationally
- protecting strategic industries
- protection agasint dumping (dumping = type of predatory pricing where overseas firms sell their spare production of goods at very low prices)
what are the disadvantages of protectionism
- loss of economic efficiency
- higher prices for consumers
- reduction in market access for producers (in low income countries particularly which rely on exports)
- extra costs for exporters
- adverse effects on poverty (fall on products which lower income families spend a larger % of income)
- retaliation & trade wars (tarrifs and traxs on orginal country which uses protectionism)
what is the role of WTO (world trade organisation)
to promote world trade through reducing trade barriers and policing existing agreements. it also settles disputes by acting as the jduge and also organises trade negotiations
