6) Consequences of Exchange Rate Changes - MMT Flashcards
how can floating rates be greatly impacted by changes in the interest rate, there is a … link between interest rates and exchange rates
positive
as x rates are ultimately a price…
like all prices they will fluctuate with changes in demand and supply of the currency. Often this is determined by the confidence/faith/trust that speculators have in the economic performance of the country
anything … will tend to lower the value of the x rate
negative
what is the link between growth and devaluation of fixed rates/sustained depreciation of floating rates?
with help to drive growth in the economy
why is the link between an increase in growth and devaluation of fixed rates/sustained depreciation of floating rates?
due to their impact on x and m
how can a lower x rate improve international competitiveness?
as it makes exports more attractive relative to imports and therefore increasing growth (however this may depend on the type of economy)
what can a higher/lower x rate in order to improve international competitiveness depend on?
depend on the type of economy
a higher/lower x rate in order to improve international competitiveness depending on type of economy example
eg a developed economy like the UK relies greatly on strategic imports eg oil, may find that higher import prices could harm growth
countries for whom exports are the main drivers of their economy eg China, may prefer low x rates to continuously drive growth
why is a stable x rate preferable to a highly volatile one?
due to uncertainty undermining confidence
why is it bad if the x-rate is changing all the time?
it becomes very difficult for firms to maintain the prices at a stable level
what is a major problem for countries with fixed rates?
the concept of imported inflation, if prices increase in countries that they trade with then they will tend to import those price increases into their economy
in countries with floating rates, how can imported inflation be avoided?
by adjustments in the x rate, however, it is generally the case that a strong currency can help to limit the effects of inflation, a weak currency exposes the economy to more inflationary risk
what does a strong currency mean for employment?
a strong currency may harm the export sector costing jobs
what does a weak currency mean for employment?
a weak pound may benefit exporting businesses creating jobs (however this depends on the nature of the industry)
why might a weak currency possibly not generate many jobs?
- it depends on the nature of the industry, eg capital intensive industries like car manufacture may benefit from a weak currency but not necessarily create too many new jobs
- it also depends on the duration of x-rate changes, eg if the x-rate increases one week but declines the next then businesses are unlikely to make any changes in investment or employment as a result
- long term changes in x-rate may have more of an impact
what does a low currency mean for the balance of payments?
- a low currency will help to drives BoP current account trade surplus (imports are dearer)
- for this reason, countries like China are keen to keep their x-rate at artificially low levels to ensure that their huge current account surplus is protected
what does a strong currency mean for the BoP?
often create a BoP current account deficit
what is an example of strong currencies leading to surpluses in the financial account?
the USA imports large volumes from China; the strong US$ helps to enhance this trend by making Chinese imports relatively cheaper
however it depends on which side of balance of payments we look at, the current account or the financial account
strong currencies lead to …. in the financial account of the BoP
surpluses
weak currencies lead to …. in the financial account of the BoP
large deficits
why do China have a financial account deficit?
China is awash with foreign currency (earned from their exports) and they use this foreign currency to invest huge sums overseas - a financial account deficit
edt do other countries possess vast amounts of US$?
the USA imports so much, other countries possess vast amounts of US$s, they use this to invest in American financial assets - i.e the money ends up in Wall street!
what does the size/extent of any change mean?
minor fluctuations have little effect, big fluctuations have big effects
hour are exchange rates relevant to time?
how long any upward or downward trend is sustained for, obviously one day movements have less effect than one year trends
how do time-lags with devaluation tie into trade deficits?
devaluations in the short-term might not reduce a trade deficit but in the longer term, when the impact of the lower currency has kicked in, they might reduce the deficit (J-curve effect)
how does PED affect imports and exports? (short term)
the Marshall Lerner condition, which creates the J-Curve effect above. If the combined PED of x and m < than -1 (ie Price inelastic) then the change in value of x and m will be less than the change in rate
this is explained by the fact that in the short-term changes, changes in the x-rate may not impact levels of x and m by much, eg due to companies being tied in to contracts, lack of suitable alternatives etc
how does PED affect imports and exports? (long term)
the Marshall Lerner condition, which creates the J-Curve effect above. If the combined PED of x and m < than -1 (ie Price inelastic) then the change in value of x and m will be less than the change in rate
in the longer term, demand for x and m will be much more sensitive to x-rate changes ie more elastic
