Exchange rates

Question 1

the marshal Lerner condition definition

Answer 1

following a depreciation of an exchange rate the balance of trade will only improve if the sum of price elasticities of demand for export and imports is elastic (greater than 1)

Question 2

the marshal Lerner condition calculation

Answer 2

PED x + PED m> 1

Question 3

exchange rates

Answer 3

the price of a currency in terms of another Currency

Question 4

3 factors causing an appreciation of a currency

Answer 4

1. increased interest rates in a domestic country
2. low inflation compared to other countries
3. speculation

Question 5

how can government intervention devalue the exchange rate

how may a government fix an exchange rate

Answer 5

China have bought a lot of US dollars to increase the value of the dollar compared to the yuan.

This keeps the Chinese currency undervalued and their exports become more competitive as a result.

Question 6

purchasing power parity (real exchange rate)

Answer 6

The exchange rate that equalises the purchasing power in two economies

It means at this exchange rate you can buy the exact same basket of goods.

Question 7

3 reasons why can’t ppp be achieved

Answer 7

1. trade barriers
2. transport costs
3. political agreements

Question 8

how can exchange rates be used to control the economy

Answer 8

devaluing the exchange rate= export led growth

revaluing the exchange rate limits growth and inflation

Question 9

how does a country devalue its exchange rate

Answer 9

for example china bought lots of dollars with yuan

Question 10

What does the financial account include

BOP

Answer 10

1. portfolio investments (trading bonds and shares)
2. Foreign direct investment
3. reserves of money

Question 11

What must the balance of payments do

Answer 11

balance

Question 12

What is it called when something money comes into the UK

Answer 12

Credit

Question 13

what is it called when money leaves the UK

Answer 13

Debit

Question 14

why do countries (such as the US) operating on a current account deficit have a Financial account surplus

Answer 14

1. as these countries with a current account surplus (China) have massive reserves of cash which can be used to invest in US portfolio.

as dollars have no value in china, Chinese firms may be forced to reinvest via FDI and a financial account surplice may occur

Question 15

3 demand side causes of a current account deficit

Answer 15

1. overvalued pound (imports become cheaper)
2. high consumer spending
3. lack of competitiveness

Question 16

3 examples is a current account deficit ok

Answer 16

1. when the current account deficit is financed by FDI in the financial account
2. when the current account deficit is as a result of growth.
3. if the economy is near full capacity and may prevent inflation

Question 17

give an example where the current account deficit was financed by FDI

Answer 17

As incomes were rising in the UK in the 1980’s we bought lots of Japanese electronics such as TV using pounds.

This meant the Japanese had lots of pounds which was invested back into the UK through FDI.

Such as the Toyota factory which was set up in 1989 which employs around 3000

Question 18

industries which have been uncompetitive in the UK

Answer 18

1. bakeries
2. game development
3. car manufacturing.

Question 19

3 supply side causes of a current account deficit

Answer 19

1. low productivity
2. high labour costs
3. low investment
   Which may lower competitiveness causing people to buy abroad

Question 20

problems with a current account deficit

Answer 20

1. falling in ad and reduction in growth

2. causes a depreciation in the exchange rate causing cost push inflation as imports become more expensive

Question 21

problems with using the exchange rate as monetary policy

Answer 21

1. has an asymmetric impact on the economy. those who import (eg tourism) more will better benefit from a weak pound
2. Can cause international trade wars (eg China and the USA)

Question 22

reasons a exchange rate may depreciate

Answer 22

1. high inflation
2. lower interest rates discourage hot money flows
3. poor quality products

Question 23

what’s the benefit of a fixed exchange rate

Answer 23

1. if the exchange rate is fixed at a low price is may attract exports and prevent imports.
   Export led growth may be caused as result
2. gives investors certainty

Question 24

why may the current account deficit be financed by FDI

Answer 24

if US were to buy Chinese toys using dollars. The Chinese must reinvest the dollars back into the US economy as they have no value elsewhere.

Question 25

what occurs if the Marshall- Lerner condition holds

Answer 25

A currency depreciation will lead to an improve balance of trade. This will make the cost of exports cheaper and export revenue greater. this will also make imports more expensive and import sending will fall

Question 26

evaluation of the ML condition

Answer 26

ML condition tends not to hold un the short run so a currency depreciation to make the balance of trade worse first. For most countries, it will get better eventually.

Question 27

Draw J curve

Answer 27

nf

Question 28

why doesn't the ML condition hold in the short run

Answer 28

1. information failure 2. contracts they both prevent buyers from switching suppliers to the cheapest possible alternative

Question 29

how can a government help solve a current account deficit

Answer 29

1. expenditure switching | 2. expenditure reducing.

Question 30

when is expenditure reducing most effective

Answer 30

1. when there is an inflationary output gap

Question 31

when would expenditure reducing not be effective

Answer 31

1. when current account deficit is caused by an overvalued exchange rate ( a rise in interest is likely to make this worse) 2. if industries are uncompetitive- by lowering domestic demand firms are less able to make profits to reinvest into their business

Question 32

how can expenditure be reduced

Answer 32

1. higher interest | 2. higher income tax

Question 33

how can expenditure be switched

Answer 33

1. protectionist measures 2. subsidising domestic firms 3. devaluing the domestic currency

Question 34

when would expenditure switching be the most effective

Answer 34

1. if industries are uncompetitive. Supply side policies may improve the productivity of uncompetitive industries and price may fall as a result as labour cost per unit decrease and profit margins can be maintained.

Question 35

define balance of payments

Answer 35

record of a country’s transactions with the rest of the world

Question 36

when is a floating exchange rate good

Answer 36

1. Monetary policy can be used independently- in a fixed exchange rate the interest rates will be used to manage the exchange rate rather than the domestic economy 2. automatic stabiliser (less vulnerable to external shocks)

Question 37

how does the automatic stabiliser work

Answer 37

1. when there is a current account deficit there is an outward shift in the supply of pounds as UK consumers may demand euros to buy foreign goods 2. this may cause a depreciation of the pound from 1.18 to 1 euros 3. as the cost of imports becomes cheaper eg the Uk are increasing spending on oil as it is inelastic and having this automatic stabiliser prevents the current account deficit from occurring

Question 38

evaluation of fixed exchange rate

Answer 38

1. we may not want to devalue it as inflation is so high at 7% 2. it may be difficult to set it at the right level as the government has imperfect information. 3. may be beneficial if the country is super reliant on international trade

Question 39

negatives of a fixed exchange rate

Answer 39

1. it may make domestic reliant on the exchange rate and they may become uncompetitive in the long term. 2. may make imports more expensive if the exchange rate is weakened

Question 40

semi fixed exchange rate system

Answer 40

when the exchange rate is allowed to fluctuate day to day between a specified range

Question 41

why may the current account not be financed by FDI

Answer 41

1. the economic climate in the UK is uncertain with party gate and investors are unsure as to what policies may be implemented and may be reluctant to invest 2. low confidence

Question 42

when is a current account deficit bad

Answer 42

1. Poor international competitiveness 2. Domestic industries may be struggling 3. When not financed by inflows of investment a current account deficit will put downward pressure on your currency

Question 43

evaluation of a depreciating exchange rate

Answer 43

not all firms in the UK will be reliant on imports so the extent it may cause cost push inflation can be questioned