Exchange Rates Flashcards
Define ‘exchange rate’.
The value of one currency in terms of another
What are the 2 equations related to exchange rates?
Foreign Currency = Home Currency x Exchange Rate
Home Currency = Foreign Currency ➗ Exchange Rate
Define ‘appreciation’.
When one currency gets stronger against another
Define ‘depreciation’.
When one currency gets weaker against another
How does an appreciation of a currency affect the 4 macroeconomic objectives?
Economic growth: ↓
Inflation: ↓
Unemployment: ↑
CA: worsens
How does a depreciation of a currency affect the 4 macroeconomic objectives?
Economic growth: ↑
Inflation: ↑
Unemployment: ↓
CA: improves
What are the 6 factors that affect the demand for a currency?
Demand for exports ↑ Increased FDI in home country Relatively high interest rates Relatively low inflation Increased tourism Increased speculation of appreciation
What are the 6 factors that affect the supply of a currency?
Demand for imports ↑ Increased FDI in foreign countries Relatively low interest rates Relatively high inflation Decreased tourism Increased speculation of depreciation
How does the demand for exports increasing affect the exchange rate? (2 steps)
1) Demand for home currency increases
2) Causes currency to appreciate
How does the demand for imports increasing affect the exchange rate? (2 steps)
1) Increase in demand for imports leads to more supply of home currency available
2) Causes the currency to depreciate
How does increased FDI in a country affect its exchange rate? (2 steps)
1) Causes demand for home currency to increase
2) Causes currency to appreciate
How does increased FDI in foreign countries affect the home country’s exchange rate? (2 steps)
1) Domestic companies investing in foreign countries leads to FDI in other countries
2) Causes home currency to depreciate
How do relatively high interest rates affect the exchange rate? (2 steps)
1) They can attract more “hot money” inflow - demand for currency increases
2) Currency appreciates
How do relatively low interest rates affect the exchange rate? (2 steps)
1) Can cause “hot money” flow outwards
2) Causes currency to depreciate
How does relatively high inflation affect the exchange rate? (3 steps)
1) Can cause exports to become less competitive
2) Preference for imports increases
3) Supply of currency increases - depreciation
How does relatively low inflation affect the exchange rate? (3 steps)
1) Domestic goods become more competitive
2) Demand for exports increases - appreciation
How does increased tourism affect the exchange rate? (2 steps)
1) Increased demand for foreign currency
2) Appreciation
How does decreased tourism affect the exchange rate? (2 steps)
1) Tourists leave the domestic economy - increased supply of currency
2) Depreciation
How does increased speculation of appreciation affect the exchange rate?
1) Demand for currency increases
2) Appreciation
How does increased speculation of depreciation affect the exchange rate?
1) Supply of currency increases
2) Depreciation
How does a current account deficit correct itself? (5 steps)
1) Demand for imports increases (M > X)
2) Supply > Demand - depreciation
3) WPIDEC - Weak Pound, Imports Dearer, Exports Cheaper
4) M↓, X↑
5) Current account improves
How does a current account surplus correct itself? (5 steps)
1) Demand for exports increases (X > M)
2) Demand > Supply - appreciation
3) SPICED - Strong Pound, Exports Cheaper, Imports Dearer
4) X↓, M↑
5) Current account worsens
How might self correction not take place?
Due to inelastic goods traded like oil:
If a country is in a CA deficit and their currency’s weakening, they’ll still purchase relatively the same amount of oil at a higher price - CA worsens
What are the 2 features of a free-floating exchange rate system?
Value of currency based on demand and supply
No intervention by the central bank
What are the 3 features of a fixed exchange rate system?
Value of one currency fixed against another
Requires a high level of intervention - price highly monitored by both central banks
Revaluation/devaluation ONLY occurs in this system
Define ‘revaluation’.
When the official exchange rate is intentionally increased in strength against another currency
Define ‘devaluation’.
When the official exchange rate is intentionally reduced in strength against another currency
