4.2Exchange Rates Flashcards
What is an exchange rate?
The value of one currency in terms of another currency.
What is the spot exchange rate?
Today’s prices for currency exchange.
What is a forward exchange rate?
Delivery of currency at a future date at an agreed rate.
What is a bilateral exchange rate?
Rate at which one currency can be traded against another.
What is the Effective Exchange Rate Index?
A weighted index of a currency’s value against a basket of currencies.
What is the real exchange rate?
Purchasing power of two currencies relative to one another, adjusted for inflation.
What does appreciation of a currency mean?
The currency is becoming stronger, allowing it to buy more foreign currency.
What does depreciation of a currency mean?
The currency is becoming weaker, allowing it to buy less foreign currency.
What is the acronym SPICED used to remember?
Strong Pound Imports Cheaper Exports Dearer.
What does WPIDEC stand for?
Weak Pound Imports Dearer Exports Cheaper.
What are the three types of exchange rate systems?
- Freely floating
- Managed
- Rigidly fixed
What determines the value of a freely floating exchange rate?
Supply and demand for the currency in foreign exchange markets.
What is a dirty floating exchange rate?
A floating exchange rate with occasional government intervention.
What is a managed exchange rate system?
A system where the central bank regularly intervenes to regulate currency value.
What is an adjustable peg exchange rate?
A system where the currency is fixed to a strong currency with some movement allowed.
What is a rigidly fixed exchange rate?
The value is set against another currency or a commodity like gold.
What is the Marshall Lerner Condition?
A rule that states a fall in currency value will improve the balance of payments if the sum of the price elasticities of demand for exports and imports is greater than 1.
What is the J Curve effect in economics?
The phenomenon where a current account deficit initially worsens after a currency depreciation before improving.
What is the likely consequence of a rise in demand for UK exports?
The value of the £ will appreciate.
What happens to the Balance of Payments current account when the value of the £ rises?
It can lead to a deficit due to more expensive exports.
List one advantage and one disadvantage of a floating exchange rate system.
- Advantage: Adjusts to changes in the economy
- Disadvantage: Vulnerable to speculation
List one advantage and one disadvantage of a fixed exchange rate system.
- Advantage: Provides stability
- Disadvantage: Can lead to a Balance of Payments crisis if overvalued
What are the potential government interventions in a managed exchange rate system?
- Buying or selling currency reserves
- Changing interest rates
- Revaluing or devaluing the currency
What is the main aim of a managed exchange rate system?
To combine stability of fixed rates with the responsiveness of floating rates.
True or False: An increase in the Bank of England base rate typically leads to an appreciation of the £.
True
Fill in the blank: An overvalued currency can lead to _______ on the Balance of Payments current account.
deficit
What is one outcome of a long-term decline in demand for a currency?
The central bank may be forced to devalue the currency.
What does a rise in the value of the £ imply for imports?
Imports become cheaper.
What is the relationship between exchange rates and the Balance of Payments?
Exchange rates directly affect the current account balance.
What is the primary factor affecting the value of a freely floating exchange rate?
Market supply and demand.
