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Macro > chapter 13 > Flashcards

chapter 13 Flashcards

1
Q

what is a floating currency

A

A currency whose exchange rate is determined by the demand for and supply of the currency in the foreign exchange market.

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2
Q

Exchange rate system

A

An agreement between countries on how exchange rates should be determined.

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3
Q

managed float exchange rate system

A

Australia has been using a managed float system since 1983 where the $AU is determined by market forces with the occasional intervention of the central bank

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4
Q

the Australian currency is one of the world’s currencies with the

A

least amount of central bank intervention

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5
Q

fixed exchange rate systems

A

countries agree to keep the exchange rates between their currencies fixed. e.g. gold standard and Bretton Woods system

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6
Q

The current exchange rate system has three important aspects:

A

1 Australia, like Britain and the United States, allows its currency to float against other major currencies.

2 Most countries in Western Europe have adopted a single currency, the euro.

3 Some developing countries have attempted to keep their currencies’ exchange rates fixed against the US dollar or another major currency.

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7
Q

TWI

A

measure the value of the Australian dollar against a basket of currencies of its major trading partners based on volume of trade carried out in that currency

e.g. If Australia carries out most of its trade in Japanese yen, then the index will give a higher weight to the exchange rate against the yen than against the currency of a country with which Australia trades less, such as Thailand.

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8
Q

when was Australian dollar floated

A

December 1983

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9
Q

by 2011 had reached its highest level in more than 28 years, largely due to

A

the depreciation of the US dollar against many major currencies and the strong foreign demand for Australia’s minerals and energy.

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10
Q

In the short run, the two most important causes of exchange rate movements are

A

changes in interest rates and speculators’ expectations

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11
Q

What determines exchange rates in the long run?

describe purchasing power parity

A

long run exchange rates move to equalise the purchasing power of different currencies.

the purchasing power of every country’s currency should be the same

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12
Q

If exchange rates are not at the values indicated by purchasing power parity

A

there are opportunities to make profits

as people attempted to make these profits by exchanging pounds for Australian dollars they would bid up the value of the Australian dollar until it reached the purchasing power exchange rate of $1 = £1

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13
Q

§Three real-world complications keep purchasing power parity from being a complete explanation of exchange rates, even in the long run.

A
  1. not all products are traded internationally –> exchange rate will not reflect purchasing power of the currencies
  2. products and consumer tastes are different internationally –> higher price in one country b/c consumers prefer it. identical products may have same price, but similar products do not
  3. countries impose barriers to trade
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14
Q

The four determinants of exchange rates in the long run

A
  1. relative price levels
  2. relative rates of productivity growth
  3. preferences for domestic and foreign goods
  4. tariffs and quotas
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15
Q

The four determinants of exchange rates in the long run

relative price levels

is the purchasing power parity theory correct?

A

If prices of goods and services rise faster in Australia than in the United States, the value of the Australian dollar has to decline to maintain demand for Australian products.

it is correct

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16
Q

The four determinants of exchange rates in the long run

relatives rates of productivity growth

A

productivity –> more goods and servicies produced using fewer inputs –> production costs fall –> product price falls

so if jap’s productivity rises faster than australia, value of yen will rise against $AU

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17
Q

The four determinants of exchange rates in the long run

Preferences for domestic and foreign goods

A

prefer foreign goods, foreign currency will appreciate

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18
Q

The four determinants of exchange rates in the long run

tariffs and quotas

A

reduced demand for imports –> demand for foreign currencies fell

$AU rises

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19
Q

what is the euro

A

a common currency used by Eurozone (the EU countries who have adopted the euro)

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20
Q

what happend in 2002?

A

On 1 January 2002 euro coins and paper currency were introduced

ECB was established

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21
Q

Role of ECB

A

§The ECB determines monetary policy for the euro zone member nations (but member countries continue to have their own central bank)

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22
Q

adv of common euro

A

makes it easier for consumers and firms to buy and sell across borders.

reduce costs and increase competition.

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23
Q

cons of euro

A

participating countries cannot run independent monetary policies

currency cannot depreciate during an economic contraction or a recession, which would normally expand net exports to help revive aggregate demand.

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24
Q

what have some developing economies attempted to do in terms of their exchange rate?

A

some developing countries have attempted to keep their exchange rates fixed against the US dollar or another major currency.

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25
Q

benefits of a fixed exchange rate

A

§Formerly used by some developing or emerging nations: e.g. Thailand, South Korea, Indonesia and Malaysia.

–Makes business planning easier.

–Fixes foreign debt levels and repayments.

–Reduces fluctuations in import prices.

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26
Q

§Pegging a currency can create problems.

A

–Can lead to persistent surpluses or shortages of currency.

–The central bank becomes burdened to buy up currency surpluses to maintain the fixed exchange rate.

–This has meant some countries have had to borrow money from overseas to buy up their own currency surplus, e.g. Thailand.

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27
Q

how may a surplus be created by pegging the exchange rate to the US

A

in thailand, a surplus in Baht was created b/c it was above the market equlibrium rate. It is overvalued

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28
Q

define

overvalued

undervalued

A

A currency pegged at a value above the market equilibrium exchange rate is said to be overvalued.

A currency pegged at a value below the market equilibrium exchange rate is said to be undervalued.

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29
Q

what did thailand do to keep keep the exchange rate at the pegged level

A

the Thai central bank, the Bank of Thailand, had to buy these baht with US dollars.

gradually used up its US dollar reserves —> the Bank of Thailand borrowed additional US dollar reserves from the International Monetary Fund (IMF).

also raised interest rates to attract more foreign investors to investments in Thailand, thereby increasing the demand for the baht –> lowered AD –> recession

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30
Q

destabilising speculation?

A

As investors became convinced that Thailand would have to abandon
its pegged exchange against the US dollar and allow the value of the baht to fall, they decreased their demand for baht from D1 to D2

This increased the quantity of baht the Bank of Thailand had to purchase in exchange for US dollars from 70 million per day to 140 million to defend the pegged exchange rate.

The destabilising speculation by investors caused Thailand to abandon its pegged exchange rate in July 1997

31
Q

Destabilising speculation may occur in

A

–in anticipation of abandoning the peg, which makes maintaining the peg even more difficult.

32
Q

–capital flight.

A

Foreign investors also began to sell off their investments in Thailand and exchange the baht they received for US dollars.

This capital flight forced the Bank of Thailand to run through its US dollar reserves quickly. Dollar loans from the IMF temporarily allowed Thailand to defend the pegged exchange rate.

33
Q

speculative attacks

A

Many currency traders became convinced that other East Asian countries, such as South Korea, Indonesia and Malaysia, would have to follow Thailand and abandon their pegged exchange rates.

The result was a wave of speculative selling of these countries’ currencies.

34
Q

Even if a country’s currency was not initially overvalued at the pegged exchange rate, the speculative attacks would

A

cause a large reduction in the demand for the country’s currency. The demand curve for the currency would shift to the left, which would force the country’s central bank to run through its US dollar reserves quickly.

35
Q

Due to speculative attacks

A

a few months, South Korea, Indonesia, the Philippines and Malaysia abandoned their pegged currencies. All these countries also plunged into recession.

36
Q

what happened to pegged exchange rates after the east asian exchange rate crisis?

A

sharply declined

37
Q

graph destabilising speculation

A
38
Q

what happened to china in 1994

A

The chinese yuan was peggeed against the US dollar at a fixed rate of 8.28 yuan to the US dollar

it was undervalued against the US dollar

39
Q

pegging against the US dollar assured what?

A

US dollar ensured that Chinese exporters would face stable US dollar prices for the goods they sold to the United States

40
Q

what did the undervalued yuan give?

A

e undervaluation of the yuan gave Chinese firms an unfair competitive advantage on international markets.

41
Q

how did China support their undervalued yuan?

A

the Chinese central bank had to buy large amounts of US dollars with yuan. By 2005 the Chinese government had accumulated more than US$700 billion

42
Q

what did China’s trading partners pressure it to do?

A

to allow the yuan to increase in value b/c it chinese textile exports drove textile producers out of business in Japan, US, Australia and Europe

43
Q

why was the chinese gov reluctant to revalue the yuan

A

since China’s had large holdings of US dollars, it would also incur significant losses if the yuan increases in value.

44
Q

what happened in July 2005 in China?

A

switched from a peg to a managed floating exchange rate

he government announced that it would switch from pegging the yuan against the US dollar to linking the value of the yuan to the average value of a basket of currencies—the dominant currencies were the US dollar, the Japanese yen, the euro and the Korean won, while several other currencies were also considered, including the Australian dollar

45
Q

what did economists argue after 2005

A

Some economists and policy-makers were sceptical that anything had changed b/c because initial increase in the value of the yuan was small and because the Chinese central bank did not explain the details of how the yuan would be linked to the basket of other currencies

in 2010, they believed the yuan was still undervalued

46
Q

In 2010 China announced

A

a renewed commitment to moving towards a more flexible exchange rate system and the value of the yuan slowly increased and by 2014 had reached above US$1 = 6 yuan

47
Q

after 2010, what was argued

A

ome economists and policy-makers still believe the yuan is undervalued and urged the Chinese government to allow its currency to become more responsive to changes in demand and supply in the foreign exchange market

48
Q

2014: how much $US did China hold

A

3.4 trillion

49
Q

One important reason exchange rates fluctuate is that

A

nvestors seek out the best investments they can find anywhere in the world.

For instance, if Chinese investors increase their demand for Australian securities, the demand for Australian dollars will increase and the value of the Australian dollar will rise. But if interest rates in Australia decline, foreign investors may sell Australian securities and the value of the Australian dollar will fall.

50
Q

capital markets?

A

where shares in companies and long-term debt, including corporate and government bonds and bank loans are bought and sold

51
Q

what happened In the 1980s and 1990s

A

European governments removed many restrictions on foreign investments in financial markets.

It became possible for foreign investors to invest freely in Europe and for European investors to invest freely in foreign markets.

52
Q

in the 1980s, what happened in Australia?

A

§Australia deregulated its capital markets to allow the free flow of capital into and out of Australia.

53
Q

The globalisation of financial markets has

A

helped increase growth and efficiency in the world economy.

54
Q

The globalisation of financial markets has made it possible

A

for the savings of households around the world to be channelled to the best investments available

firms borrow from overseas to finance investment

55
Q

Disadvantage of globalisation of financial markets?

A

financial securities are held by investors around the world, if they decline in value, the financial impact will be widespreading

e.g. the sharp decline in the value of mortgage-backed securities issued in the United States hurt not only US investors and financial institutions but investors and financial institutions in many other countries as well.

56
Q

If the average rate of productivity growth in South Korea is greater than in Australia over the next five years, then, all else being equal, will the savings that you accumulate (in Korean won) be worth more or less in Australian dollars than it would have been worth without the relative gains in Korean productivity?

A

the value of the faster-growing (productivity) country’s currency should—all else being equal—rise against the slower-growing (productivity) country’s currency.

  • savings that you accumulate in won while you are in South Korea are likely to be worth more in Australian dollars than they would have been worth without the gains in Korean productivity
57
Q

describe feature of the gold standard

A

the currency of a country consisted of gold coins and paper currency that could be redeemed for gold.

the exchange rate between two currencies was automatically determined by the quantity of gold in each currency.

58
Q

why was the gold standard abandoned?

A
  • country’s money supply relied on gold supply which dependend on disoveries of gold –> central bank had no control of money supply (to pursue monetary policy) b/c it did not know how much gold would be discovered
59
Q

when was the gold standard abandoned

A

before, during and after the Great Depression to allow the Central Bank to expand the money supply in pursuit of an expansionary monetary policy

the later the gold standard was abandoned, the further the fall in productoin

60
Q

The Bretton Woods System

A

§An exchange rate system that lasted from 1944 to 1971, under which countries pledged to buy and sell their currencies at a fixed rate against the US dollar.

61
Q

distinguish between revaluation and devaluation

A

§Devaluation: A reduction in a fixed exchange rate.

§Revaluation: An increase in a fixed exchange rate.

62
Q

The collapse of the Bretton Woods System

what happened in the 1960s?

A
  1. The number of $US held by foreign banks was more than the gold reserves in the US.
  2. Some countries with undervalued currencies refused to revalue them, e.g. West Germany.
63
Q

Under the Bretton Woods System central banks were committed to

A

selling US dollars in exchange for their own currencies. They had to hold US dollar reserves. If a central bank ran out of US dollar reserves it could borrow them from IMF

64
Q

Under the Bretton Woods System, a fixed exchange rate was

A

Under the Bretton Woods System, a fixed exchange rate was known as a par exchange rate.

65
Q

explain this graph

A

Qty of British pounds demanded is lower than the Qty of british pounds supplied in exchage for $US

so Bank of England must use US dollars to buy the surplus

66
Q

when is there a fundamental disequilibrium in a country’s exchange rate?

A

when there is a persistent shortage or surplus of a currency

67
Q

in the early years of the Bretton Woods system,

A

many countries found that their currencies were overvalued against the US dollar, meaning that their par exchange rates were too high.

68
Q

The collapse of the bretton woods

why was it a problem that the US dollars held by foreign central banks was larger than the gold reserves of the United States?

A

Due to the large gap, the US could not redeem US for gold

69
Q

Collapse of the Bretton Wood

why did gov with undervalued exchange rates refuse to revalue it?

A

it would have increased the prices of their countries’ exports.

70
Q

diagram of an undervalued exchange rate

A
71
Q

Under the Under the Bretton Woods System, what did Germany’s central bank have to do?

A

Bundesbank had sell deutsche marks and buy $US. The supply = the shortage at the par exchange rate

72
Q

what happpened in the 1960s in europe

A

most European countries, including Germany, relaxed their capital controls (limits on the flow of foreign exchange and financial investment across countries)

73
Q

what were effects of loosening capital control?

A

made it easier for investors to speculate on changes in exchange rates.

§Destabilising speculation made it very difficult to maintain a fixed exchange rate: investors expectated Bundasbek to revalue so they demanded marks to make profit

74
Q

draw diagram to show DESTABILISING SPECULATION AGAINST THE DEUTSCHE MARK

A

Macro (12 decks)

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