4.5 Exchange Rates Flashcards
What is floating exchange rates + the graph
Exchange rates are determined by the forces of demand and supply with no government or central bank intervention
What is an appreciation of a currency + the graph for it
An increase in the value of a currency in a floating exchange rate system
What is a deprecation of a currency + show on graph
A fall in the value of a currency in a floating exchange rate system
What are factors that affect the changes in currency demand
foreign demand for exports - if there is an increase in exports, demand for currency increases, currency appreciates
Rate of inflation relative to other countries - if country has lower inflation rate then other counties, demand for its exports increase as they are relatively less expensive, demand for currency increases, currency appreciates
Inward FDI - if investments are coming into the country, money is brought from abroad by demanding domestic currency, causing appreciation
Relative interest rates - if country has high interest rate, it is more attractive to save in that country, increasing demand for that currency, causing an appreciation
Inward flow of remittances - increase in remittance (transfer of money from one country to another by workers living abroad) into a country sent from abroad, causes an increase in demand from the countries currency, causing an appreciation
Speculation that currency will appreciate - if currency speculators expect country’s currency to appreciate, they will buy it hoping to sell it after appreciation, as they purchase currency, cause an appreciation
Central bank intervention to increase the value of a currency - if central bank wants to increase value of currency, it demand (buys) the domestic currency by selling foreign currencies
What are factors that affect the changes in currency supply
Domestic demand for imports - if countries demand for imports increases, they must sell their currency to buy foreign currency, increasing supply causing a deprecation
Rate of inflation relative to other countries - if country has lower inflation then other countries, demand for imports decrease as they are more expensive compared to domestic goods, supply of currency decreases causing an appreciation
Outward FDI - if country invest in other countries, then their currencies supply will increase, causing a deprecation
Relative interest rates - if interest rates in a country are low, investment will flow out of the country, and supply of currency will increase causing deprecation
Outward flow of remittances
Speculation that currency will depreciate - if speculators expect a countries currency to depreciate they will sell it, increasing supply
Central bank intervention - supplies (sells) more of the domestic currency by buying foreign currencies
Consequences of changes in exchange rate on inflation rate
Affected in 2 ways:
Demand-pull inflation - a currency deprecation makes exports cheaper and imports more expensive, increasing quantity of exports, increasing net exports, results in a rightward shift of the AD curve, causing inflationary pressure
Cost-push inflation - a currency deprecation makes imports more expensive, if domestic producers are dependent on imported FOP, their costs of production increase, resulting in a leftward shift of the SRAS, causing inflationary pressures
Consequences of changes in exchange rate on economic growth
Depreciation - exports cheaper, imports expensive - increase in quantity of exports - increasing net exports - increasing AD - economic growth
Consequences of changes in exchange rate on unemployment
Currency deprecation, increases net exports and therefore AD, causing fall in cyclical unemployment or a temporary decrease in natural unemployment
Consequences of changes in exchange rate on current accounts balance
Deprecation, causes imports to decrease and exports to increase will lead to a trade surplus
Consequences of changes in exchange rate on living standards
Deprecation, causes imports to be more expensive, residents become worse off as imported goods become more expensive
What is a fixed exchange rate system
Situation where exchange rates are fixed by the central bank at a particular level, and are not permitted to change freely in responde to changes in market forces
Graph showing how the currency’s demand curve is shifted
Graph showing how currency’s supply curve is shifted
Intervention to matiz in a fixed change rate
Using official reserves - central bank can purchase excess domestic currency by selling its foreign currency reserves
Increases in interest rates - central bank can increase IR, which attracts investments, increasing demand for domestic currency
Borrowing from abroad - if country borrows demo abroad, its loans will come in the from of foreign exchange, when converted into domestic currency will cause an increase in demand
Limit imports - government can use policies to limit imports, as it reduces supply of the domestic currency causing leftward shift in the currrenct
What is a devaluation of a currenct
When the value of a currency decreases in a fixed exchange system
