Exchange rates Flashcards
the marshal Lerner condition definition
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
the marshal Lerner condition calculation
PED x + PED m> 1
exchange rates
the price of a currency in terms of another Currency
3 factors causing an appreciation of a currency
- increased interest rates in a domestic country
- low inflation compared to other countries
- speculation
how can government intervention devalue the exchange rate
China have bought a lot of US assets (US exports) 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.
purchasing power parity (real exchange rate)
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.
3 reasons why can’t ppp be achieved
- trade barriers
- transport costs
- political agreements
how can exchange rates be used to control the economy
devaluing the exchange rate= export led growth
revaluing the exchange rate limits growth and inflation
how does a country devalue its exchange rate
for example china bought lots of dollars with yuan
What does the financial account include
BOP
- portfolio investments (trading bonds and shares)
- Foreign direct investment
- reserves of money
What must the balance of payments do
balance
What is it called when something money comes into the UK
Credit
what is it called when money leaves the UK
Debit
why do countries (such as the US) operating on a current account deficit have a Financial account surplus
- as these countries with a current account surplus (China) have massive reserves of cash which can be used to invest in US portfolio
- or by issuing bonds and shares to finance current account deficit
3 demand side causes of a current account deficit
- overvalued pound (imports become cheaper)
- high consumer spending
- lack of competitiveness
3 examples is a current account deficit ok
- when the current account deficit is financed by FDI in the financial account
- when the current account deficit is as a result of growth.
- if the economy is near full capacity and may prevent inflation
give an example where the current account deficit was financed by FDI
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
industries which have been uncompetitive in the UK
- bakeries
- game development
- car manufacturing.
3 supply side causes of a current account deficit
- low productivity
- high labour costs
- low investment
Which may lower competitiveness causing people to buy abroad
problems with a current account deficit
- falling in ad and reduction in growth
2. causes a depreciation in the exchange rate causing cost push inflation as imports become more expensive
problems with using the exchange rate as monetary policy
- has an asymmetric impact on the economy. those who import (eg tourism) more will better benefit from a weak pound
- Can cause international trade wars (eg China and the USA)
reasons a exchange rate may depreciate
- reducing export revenues as a result of unattractive exports (high inflation) causes a deterioration in the current account in the balance of payments. As less is exported less domestic currency is demanded.
- lower interest rates discourage hot money flows
what’s the benefit of a fixed exchange rate
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
why may the current account deficit be financed by FDI
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.
