Exchange rate

Question 1

How does expectation affect ER?

Answer 1

Expectations on appreciation of assets in different currencies drives the demand for currencies and therefore price

Question 2

If the risk of holding £ assets rises then…

Answer 2

Speculators sell £’s causing a depreciation unless IR is raised

Question 3

Bretton woods 1945-73

Answer 3

System of exchange rates fixed against the £/$ backed by gold

Question 4

Purpose of BW?

Answer 4

Create stable ER that helped trade

Question 5

3 ways the BW was maintained

Answer 5

IMF loaned to countries with fundamental imbalances in trade
International capital movements restricted
One off devaluations approved

Question 6

Success of BW

Answer 6

World trade grew 290% 1948-1968

Question 7

Flaws of BW

Answer 7

Fixed ER inappropriate with varying international growth rates and balance of payments

Question 8

3 Steps to Euro

Answer 8

Maastricht agreement 1991 set pre-requisites for joining Euro
Exchange Rate Mechanism (ERM) tied Euro currencies to the Mark
Countries had to commit to fix their ER

Question 9

ERM crisis (3)

Answer 9

German investment into Eastern Germany caused increased MD not off set by an expansion in MS
This created IR to rise in Germany
Economies in recession including UK had speculators selling £ forcing UK to drop ERM

Question 10

Criteria to join Euro (5)

Answer 10

Price stability
Budget balance
Low national debt
Equivalent IR
Fixed ER within ERM

Question 11

Stability and growth pact

Answer 11

Put restrictions of fiscal expenditure to prevent recklessness

Question 12

Credibility of the pact (2)

Answer 12

Both Germany and France went unpunished for exceeding gov borrowing limits
Pact ignored during the reccesion

Question 13

4 Benefits of single currency

Answer 13

Elimination of transaction costs
Transparency of EU prices
Reduced uncertainty
Increased international investment

Question 14

4 Costs of single currency

Answer 14

Reduced macro economic tools in recession
Loss of political/economic sovereignty
Loss of fiscal independence
Markets bet against ability to respond to crisis

Question 15

Optimal currency areas

Answer 15

An OCA has flexible labour market, members who trade with each other a lot and members with similar economic structures
This allows for easy international exchange of FOP in order to correct national disequillibriums

Question 16

Is the Eurozone an OCA?

Answer 16

Labour market flexibility is 1/3 of US
Shocks occur asymmetrically and generate different pricing
Most members trade openly but some barely trade with EU members