Exchange Rate Systems and Development Flashcards
How is the exchange rate determined when the market is free from intervention
- Exchange rate is determined from the interaction of supply and demand for a currency when there is no intervention
3 Causes of changes in Demand for a currency
- Demand for Exports
- Speculators anticipating
- FDI
3 Causes of changes in supply to an exchange rate
- Interest rates
- Speculation
- Capital Flight
what is a Fixed Exchange Rate
When a government manipulates supply and demand of its currency in order to keep exchange rate within a set value range
In a Fixed exchange rate what will government do if the:
- rate is too high
- rate is too low
- government sells domestic currency to increase supply
- government buys domestic currency with foreign currency to increase demand
3 effects of rises and falls in the exchange rate
- Impacts to growth (therefore unemployment
- Efficiency Gains ( CA surplus)
- Standard of living affects
2 evaluation points for the extent of impacts of changes in the exchange rate
- Demand/supply elasticities for imports and exports
- protectionism
3 reasons why a government may intervene in Forex markets
- to fight a current account deficit
- to fight inflation
- to fight unemployment
what is Purchasing power parity (PPP)
what is it used for
Exact exchange rate of foreign currency’s
investors use it to see if a currency is overvalued or undervalued
why might a currency be overvalued
speculative flows often dictate exchnage rates more than interaction of supply and demand
2 Pros of a Floating exchange rate
- Freedom of Domestic monetary policy
- self correction of CA deficit
2 cons of floating exchange rate
- self correction of deficit unlikely as rate is determined more by speculative flows than interaction of supply and demand
- Inflation leading to more inflation ( inflation, reducing demand for exports, reducing demand for currency, increasing import costs, therefore cost push inflation)
2 pros of a fixed exchange rate
- increased efficiency of domestic suppliers ( exchange rate would be at a level to benefit exporters and importers)
- reduces cost of trade ( no hedgeing)
3 cons of fixed exchange rates
- large risk of speculative attacks
- large reserves of currency needed
- of interest rates are used it could cause macro objective conflicts
what is the Balance of payments
System that records all economic transaction with between domestic country’s and the rest of the world
what does the balance of payment include
- current account
- financial account
- capital account
- errors and emissions
what is measured in the current account
- the value of total trade in goods and services (x-m)
- difference between earning made on foreign assets vs payments made to foreign investors
what is the balancing act of the balance of payments
FA balances Capital account and Current account therfoe total = 0
example: A country may finance the import of goods and services through attracting investment from abroad
3 causes of current account deficit
- exchange rates
- competitiveness problems
- lack of producer and consumer confidence
3 cause of current account surplus
- low relative inflation
- high FDI/FOP attraction
- Comparative advantage
2 consequences of CA deficit
- Dept burdens ( in order to create a financial account surplus a country will issue dept as the influx of money creates a surplus)
- exchange rate decreasing
2 consequences of a CA surplus
- Financial account surplus is risky ( investment may not be repaid)
- unbalanced / overspecialized economy
policy’s to reduce CA deficit
3 D’s
- deflation - contractionary monetary/fiscal policy
- direct controls - protectionism
- devaluation
policys to increase CA deficit
3 R’s
- Reflation - expansionary monetary/ fiscal policy
- Removal of controls - less protectionism
- Revaluation -
what is the Marshall learner condition
- if the Price elasticity for net exports is <1 then decreasing exchange rate will only reduce total revenue
why is the J- curve shaped the way it is
- in the short term price elasticity’s are inelastic therefore deficit will always worsen if exchange rate is reduced in the short term however the deficit will improve in the long term
- after a long period of running a CA surplus exchange rate increases as demand for exports is large therefore decreasing international competitiveness
how is a long term CA surplus achieved
policy’s to increase international competitiveness
(nonprice/price competition, ability to attract FDI, ability for EOS)
why is export led growth favourable to consumption led growth
- consumption is volatile and much is spent on imports
- export growth creates productivity and increased productive capacity in the long run therefore is a much more secure way of growing the economy
