Exchange Rates

Question 1

Exchange Rates

Answer 1

An exchange rate is just a price: the price of one country’s currency in terms of another country’s currency

Question 2

What is the term used for a currency increasing in value against another?

Answer 2

Appreciation

Question 3

The value of a currency can affect what?

Answer 3

• Economic growth rates
• Employment levels
• Inflation rate
• Foreign trade balance/ International competitiveness

Question 4

SPICED

Answer 4

Strong
Pound
Imports
Cheaper
Exports
Dearer

Question 5

WPIDEC

Answer 5

Weak
Pound 
Imports
Dearer 
Exports 
Cheaper

Question 6

What are the two categories of exchange rate systems?

Answer 6

1) Fixed exchange rates

2) Floating exchange rates

Question 7

What is a fixed exchange rate (pegged exchange rate)?

Answer 7

Pegged is where a currency’s value is fixed against the value of another currency

Question 8

Floating exchange rate

Answer 8

Where the value of the currency determined by the forces of supply and demand. Currencies bought and sold on the FOREX

Question 9

Demand for currencies

Answer 9

1) Exports
2) Inflows of investment
3) Speculative buying (HOT MONEY)
4) Central bank buying up their own currency

Question 10

Supply for currencies

Answer 10

1) Imports
2) Outflows of investment
3) Speculative selling
4) Central bank selling their own currency

Question 11

What is HOT MONEY?

Answer 11

Refers to capital flows moving to countries with higher interest rates and/or expected changes in exchange rates

Question 12

If the demand for a currency increases…

Answer 12

…the demand curve shifts right and the price of the currency (exchange rate) will increase

Question 13

If there was a shift in the supply…

Answer 13

…the exchange rate would decrease

Question 14

What types of countries tend to use Pegged exchange rates?

Answer 14

Smaller countries

Question 15

Impact of fixed rates?

Answer 15

1) Provide certainty for exporters and importers
2) Can exert a strong discipline on domestic firms and employees to keep their costs under control in order to remain competitive in international markets. Helps the government maintain low inflation
3) Can be fragile and are inflexible, they take away one of the great natural stabilisers of economic activity, exchange rates

Question 16

Floating exchange rates, central banks involvement

Answer 16

Can set interest rates for domestic economic purposes rather than to achieve a given exchange rate target

Question 17

Exchange rates are a natural stabiliser…

Answer 17

…Fluctuations in the exchange rate can provide an automatic adjustment for the countries with a large balance of payments deficit

Question 18

If an economy has a large deficit there is…

Answer 18

… a net outflow of currency from the country

Question 19

What will the impact be on the Lowering exchange rate (devaluation)?

Answer 19

• Raise AD
• Increase national output (GDP)
• Create jobs, amplified through the multiplier

Question 20

Consequences of Exchange Rate fluctuations

Answer 20

1) SPICED and WPIDEC - changing competitiveness, effect on inflation etc
2) Uncertainty - Lack of price transparency, transaction and hedging costs