Exchange Rate Systems

Question 1

What are some main advantages of floating exchange rates?

Answer 1

Automatically adjusts a current account deficit ( self-correction).
Useful absorber in a shock - currency depreciates in a recession lifting import industries.
Central bank does not need to hold large currency reserves.
Monetary policy can be used for domestic macro-objectives (employment/ price inflation)

Question 2

When did the UK leave the European exchange rate mechanism?

Answer 2

1992

Question 3

How does a floating exchange rate lead to self-correction of a current account deficit?

Answer 3

High imports are creating a deficit - currency supply increases - fall in ER - imports are more expensive - less imports

Question 4

What is an example of a floating exchange rate being an absorber of shock?

Answer 4

15% depreciation of the sterling after Brexit

Question 5

What are the disadvantages of floating exchange rate systems?

Answer 5

removes option for competitive devaluation, may be volatile inhibiting trade and inward FDI,

Question 6

What are the advantages of a fixed exchange rate?

Answer 6

creates certainty and stability for overseas investors, if fixed against a low inflation economy helps to keep costs and price under control

Question 7

What are the disadvantages of fixed exchange rates?

Answer 7

have to have efficient currency reserves to maintain rate / reduced freedom to use monetary policy for other objectives, can lead to permanent imbalance in the current account

Question 8

How much did Egypt devalue their currency by in 2022?

Answer 8

15% (against the US dollar)

Question 9

What is hot money?

Answer 9

money that flows freely around the world looking for the best rate of return

Question 11

How does inflation affect the interest rate?

Answer 11

More demand for currency due to hot money flows - appreciation