exchange rate systems

Question 1

what is a free floating exchange rate?

Answer 1

value of the currency is dictated by demand and supply

Question 2

what is managed floating?

Answer 2

no specific desired value but now and then the govt tries to influence demand and supply e.g. interest

Question 3

what is a fixed exchange rate?

Answer 3

one exchange rate is set between the currency and others e.g. £1 always = $1.65

Question 4

what is a semi fixed exchange rate?

Answer 4

exchange rate can move within a band

Question 5

what is a pegged exchange rate?

Answer 5

a currency is linked to a basket of other currencies usually the main trading partners, so if their value goes up so does the currency in question

Question 6

what are the advantages of a floating exchange rate?

Answer 6

• less need for currency reserves
• useful instrument of macroeconomic adjustment (lower currency can stimulate AD)
• provides partial automatic correction for a trade deficit by changing the relative prices of exports and imports
• freedom for domestic monetary policy

Question 7

what are the advantages of a fixed exchange rate?

Answer 7

• stability and certainty, helpful for trade and capital investment
• some flexibility
• reductions in costs of currency hedging for businesses
• fixed rate provides a discipline on domestic producers to keep costs and prices down and to become more productive
• reinforces gains in a comparative adv

Question 8

benefits of a cheaper currency?

Answer 8

• competitive boost to export sector and industries facing import competition
• increase in the value of investment income form overseas
• higher value of subsidies from overseas
• possible multiplier effect and accelerator effect
• helps rebalance the economy
• currency depreciation acts as a partial automatic stabiliser for the economy

Question 9

risks of a cheaper currency?

Answer 9

• inflationary effects from higher import prices
• weak currency may deter foreign investors
• risks for those who have borrowed a foreign currency
• low elasticity of demand may limit the impact f currency depreciation on the balance of trade
• currency devaluation does not turn around what might be long term supply side weakness in the economy