Exchange Rate

Question 1

What are the causes of a change in floating exchange rate?

Answer 1

Demand for the currency will rise if a higher value of exports is being sold. More exports may be sold if the country’s relative inflation rate has fallen, relative productivity has risen, the quality of products produced has risen or incomes abroad have increased.

Foreigners may buy more of the currency if they wish to purchase shares in the country’s firms due to the country’s economic prospects improving. They may also want to buy more of the currency in order to open accounts in the country’s banks because of higher interest rates. Such short term movements of money between countries are sometimes referred to as hot money flows.

Foreign firms may purchase a greater value of the currency in order to set up branches in the country, or perhaps because of a rise in labour productivity in the country, a growing market or to get round trade restrictions.

Question 2

Hot Money Flows

Answer 2

Flows of money moved around the world to take advantage of changes in interest rates and exchange rates.

Question 3

The impact of a depreciation on the domestic economy’s national income and real output

Answer 3

A fall in the value of the exchange rate will lead to imports becoming more expensive and exports becoming cheaper in terms of domestic currency. This may enable domestic firms to sell more products both at home and abroad.

Question 4

The impact of a depreciation on the domestic price level

Answer 4

Higher aggregate demand caused by a rise in net exports may lead to inflationary pressure. As the economy approaches full capacity, resources will become increasingly scarce, and their prices will rise. Domestic firms may also feel less competitive pressure to keep costs and prices low.

Question 5

The impact of a depreciation on the domestic economy

Answer 5

If depreciation results in higher AD, firms producing for both the domestic and external economy will be likely to take on more workers to expand their output. This may cause a decrease in cyclical unemployment

Question 6

Appreciation

Answer 6

opposite of depreciaition(check understanding of content)