7.2 A Global Perspective: Currency

Question 1

Fixed exchange rate

Answer 1

The government of a country agrees to fix the value of its currency of another country i.e. Iraq.
Called a devaluation or a revaluation

Question 2

Floating exchnage rate

Answer 2

No intervention and finds it own level in the market i.e. UK, USA, Germany
Natural rise/fall is depreciation/appreciation

Question 3

Managed exchange rated

Answer 3

Free markets determine the value of a currency but central banks interven from time to time i.e. Brazil, China, South Africa

Question 4

Facotrs influencing floating exchange rates

Answer 4

Imports (supply)
Exports (demand)
Speculation

Question 5

Floating exchange rate characteristics

Answer 5

Reduces need to hold large currency reseves
Partial automatic correction for a current account deficit

Question 6

Floating exchange rate evaluation

Answer 6

No gurantee that floating exchange rates will be stable
Volatility in floating -> detrimental to attracting inward investment

Question 7

Fixed exchange rate characteristics

Answer 7

Stability helps control inflation
Less speculation if the exchange rate is credible

Question 8

Fixed exchange rate evalution

Answer 8

Developing countires may not have sufficient currency reserves to be able to maintain a fixed exchange rate

Question 9

Managed floating exchange rates

Answer 9

Sterling free to fluctuate between undisclosed levels
If value moves away from target -> Bank of England will intervene to tip market the other way
Therefore will be ceiling and floor value

Question 10

Competitive devaluation/depreciation

Answer 10

Countries can drive to down value of currency to improve export competitiveness
Weaker currency -> encourage exports, discourages imports -> balance of payments improves
- May cause inflation -> worsens balance of payments
- Countries may retaliate
- Terms of trade deteriorate

Question 11

Marshall Lerner condition

Answer 11

States that a depreciation/devaluation of the exchnage rate will eventually lead to a net improvement in the trade balance provided that the sum of the price elasticity of demand for exports and imports > 1

Question 12

Short run J-Curve

Answer 12

When exchange rate falls it takes a while for supply to catch up with demand abroard (SPICED) -> worsens balance of payments before improving it

Question 13

What happens if a country has a weaker exchange rate?

Answer 13

Exports rise as they are cheaper -> imports fall as more expensive -> increase AD -> economic growth + employment

Question 14

What happens if there is a fall in exchange rate?

Answer 14

Inflation rises as imports rise -> prices rise, fall in SRAS. Net exports of AD rise -> prices rise even more

Question 15

What happens if there is a fall in currency?

Answer 15

FDI rises as it is cheaper to invest
However if it continues to fall it will discourage investment as it shows economic difficulty

Question 16

Relative unit labour costs

Answer 16

How much labour costs per unit of output -> cheaper it is, more competitiveness -> more productive a country is, cheaper it is

Question 17

Relative export costs

Answer 17

Ration of one country’s exports to another, expressed in an index -> lower the realtive export -> more comeptitive the country -> but worse the terms of trade