Chapter 27 Flashcards
What is exchange rate
The price of one currency in terms of another
What is a fixed exchange rate system
a system in which the governments of a country agree to fix the value of its currency in terms of that of another country (USA)
When does demand for the pound arise
When foreigners want to buy UK goods/services or assets
What does it mean for an excess supply of pounds
Currenct account deficit
What factors effect the exchange rate
Interest rates
Relative inflation rates
Growth rate
Competitiveness
Confidence/Speculation (hot money flows)
What does a depreciation in currency mean
Value of currency decreases
What does an appreciation in currency mean
Value of currency increases
How can depreciation be beneficial to a country
Increased competitiness as exports are cheaper and imports and more expensive (improving current account). Increasing economic growth and more jobs in export sector
Inflation (cost-push) if a country is dependant (inelastic) on importing resources…
How can appreciation affect a country
Imports become cheaper (worsening current account) if demand is elastic and follows marshall leaners condition
Reducing aggregate demand (X-M)
When is a falling exchange rate beneficial
It can be beneficial to a country which is in recession and uncompetitive
When is a falling exchange rate not beneficial
In a boom period
How can hot money flows effect exchange rates
If the interest rate increases in the UK, investors get more return if they convert their money into pounds. This represents an increased demand for pounds ad appreciates the value.
Causes of an appreciation in the currency
Higher interest rates. Higher interest rates make it more attractive to save in the UK, therefore more investors will switch to British banks. Therefore the value of the pound will increase.
Lower inflation. If British goods become more competitive, there will be greater demand causing the value to increase.
Current account surplus. A current account surplus means the value of exports (of goods and services) is greater than imports. This demand for UK goods tends to cause a stronger exchange rate.
What is a floating exchange rate
A floating exchange rate occurs when the government doesn’t intervene but allows the value of the currency to be determined by market forces.
What is a fixed exchange rate
This occurs when the government intervenes to try and keep the value of the currency at a certain level against other currencies. For example, in 1990, the UK joined the Exchange Rate Mechanism where the value of the Pound was supposed to keep within a certain target band against D-Mark.
