Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

[OBSELETE] S - Econ > exchange rates > Flashcards

exchange rates Flashcards

1
Q

what is a fixed exchange rate?

A

when the official exchange rate is fixed to another countrys currency

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

what is needed for a fixed exchange rate to be maintained?

A

govt/ central bank needs to hold large amounts of domestic and foreign currency reserves

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

what does the govt need to do if the exchange rate equilibrium is higher than the fixed exchange rate?

A
  • use the currency reserves its got (needs to sell the pound currency reserves its got)
  • buy foreign currencies instead
  • this will increase the supply of the pound and reduce the exchange rate
  • this reduced value of the exchange rate at equilibrium should equal the fixed exchange rate
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

draw a diagram to show the reduction in the value of the exchange rate?

A

this is how you can reduce the value of the exchange rate when there is a fixed exchange rate or when theres pressure on it rising

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

how would the govt push up the exchange rate if the initial equilibrium is lower than the fixed exchange rate?

A
  • govt needs to increase demand for the pound by using their foreign currency reserves to buy up more of the pound in the market
  • this increases the value of the pound
  • this increase in the exchange rate (which is the exchange rate at initial equilibrium) should now equal the fixed exchange rate
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

draw a diagram to show the value of the exchange rate decreasing

A
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

how can the govt change the fixed exchange rate?

A

if the UK govt decides they want to change the fixed exchange rate they can devalue the pound

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

what is depreciation of exchange rate?

A

depreciation is when the floating exchange rate falls in value

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

what is appreciation of the exchange rate?

A

appreciation is when the floating exchange rate increases in value

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

what do you say when referring to the change in the value of the exchange rate

A

when it comes to fixed exchange rate you say devalue or revalue

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

what is a floating exchange rate?

A

floating exchange rate is when a nations currency is set through supply and demand

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

what does it mean when theres a trade imbalance/ current account deficit?

A
  • importing more than exporting
  • more supply of the pound than demand for the pound
  • (have to exchange the pound in order to buy foreign imports by exchanging the pound for a foreign currency
  • this depreciates the pound
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

what happens when a currency depreciates in terms of the CA?

A
  • whenever a currency depreciates, imports become more expensive and exports become cheaper
    • this, in theory, should reduce the demand for imports which could help resolve the current account deficit
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

what determines the supply and demand of a currency

A

speculation tends to drive the demand and supply of a currency
investment (FDI)
sale of exports

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

what are the arguments for using a floating exchange rates?

A

reduces the need for currency reserves
freedom for domestic monetary policy
useful instrument for macroeconomic adjustment
partial automatic correction for a trade deficit
reduced risk of currency speculation
resource allocation

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

why do floating exchange rates reduce the need for currency reserves?

A

a floating exchange rate doesnt need large levels of currency reserves whereas fixed exchange rates do in order to maintain them which can be costly and may not be viable

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

why do floating exchange rates cause freedom for monetary policy?

A
  • some fixed exchange rate systems will require the manipulation of interest rates in order to keep an exchange rate fixed to a certain currency
  • whereas in a floating exchange rate there is no need to change interest rates to keep the exchange rate fixed
  • you can use monetary policy to deal with domestic issues in the economy such as inflation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

why is floating exchange rates a useful instrument for macroeconomic adjustment?

A

reduction in exchange rate could help e.g increase growth by increasing exports

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

how do floating exchange rates cause partial automatic correction for a trade deficit?

A

-for example if a country has a large current account deficit/ trade deficit a floating exchange rate increases the supply of the currency which will reduce the value of the currency
- makes imports more expensive and exports cheaper
- this could help partially correct a current account deficit

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

what is speculation

A

when someone who invests in foreign currency buys some currency in the hopes of selling it at an appreciated rate when market fluctuations happen

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

how do floating exchange rates reduce the risk of currency speculation?

A
  • in a floating exchange rate system, exchange rates should reach an equilibrium which reflects purchasing power parity
  • the currency is valued perfectly (not over or undervalued)
  • therefore the risk of speculative attacks are less likely to occur especially if a currency is overvalued
  • more stability as exchange rate is at equilibrium
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

recall the arguments against floating exchange rates?

A

self correction of trade deficits unlikely to occur
inflation rates causes issues with export competitiveness
volatility

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

why is self correction of trade deficits using floating exchange rates unlikely to occur?

A
  • theoretical
  • in reality its unlikely to occur
  • this is because imports and exports are only two of the factors that affect the supply and demand of a currency
  • speculative flows are more likely to affect demand and supply and change the exchange rate value
24
Q

how can inflation rates be used as an argument against floating exchange rates?

A
  • if an economy is suffering from high levels of inflation rates they may be struggling to export
  • may mean that net exports are negative
  • high inflation causes issues with export competitiveness
  • this will put downward pressure on the exchange rate
    • this is because supply of currency will be increasing more than demand for the currency which lowers the exchange rate
  • lower exchange rate may push up inflation through higher import prices and demand pull inflation
25
Q

how can volatility be used as an argument against floating exchange rates?

A
  • no guarantee that floating exchange rates will be stable
  • can reduce the incentives for foreign investors to invest in the domestic country if exchange rates are very volatile
  • foreign investors dont know what they’re getting in terms of currency
  • puts off foreign investment, trade
26
Q

recall the arguments for a fixed exchange rate?

A

lowers exchange rate uncertainty which gives confidence for inward investment
some flexibility is permitted
reduce the cost of trade (reduced hedging)
discipline on domestic producers

27
Q

how do fixed exchange rates lower exchange rate uncertainty?

A

exporters and importers know that the exchange rate will be fixed at this level
they will be more confident that the returns from their investments wont be destroyed by fluctuations in the value of the currency

28
Q

how is some flexibility permitted with fixed exchange rates?

A
  • in reality countries that have adopted a fixed exchange rate have a band within which the exchange rate can move up and down -> central peg
  • doesnt have to stay at one specific point
    central peg range can move up or down over time
  • also if a govt wants to reduce the exchange rate value they can devalue the currency
  • problem with doing this - politically not acceptable
29
Q

how can fixed exchange rates be used to reduce the cost of trade

A
  • a foreign country who wants to buy domestic goods which may have a floating exchange rate may buy some of the countries currency now even if they dont want to buy any of the countries exports to hedge against the potential rise in their currency and this is costly
  • with fixed exchange rate theres no need to hedge
30
Q

how do fixed exchange rates discipline domestic producers?

A
  • they know that they cant rely on an exchange rate falling in value as the exchange rate is fixed
  • if they are to maintain competitiveness the only way they can do that is to increase efficiency, invest, innovate
31
Q

what are the arguments against a fixed exchange rate?

A

interest rates effect
large levels of foreign currency reserves needed to maintain a fixed exchange rate?
speculative attacks if exchange rate is set too high or too low
reduced freedom to use interest rates for other maco objectives
conflict with other macro objectives
need to revise fixed rates regularly

32
Q

using fixed exchange rates unlikely to occur?

A
  • if interest rates are being used to maintain a fixed exchange rate
  • if the fixed is set at a level where the current exchange rate is lower, then the exchange rate needs to rise to meet the fixed exchange rate and this may be done by raising interest rates
  • however this may reduce growth, increase unemployment → macroeconomic consequences
33
Q

what my be needed to maintain a fixed exchange rate?

A
  • large levels of foreign currency reserves needed to maintain a fixed exchange rate?
    • can a govt hold this? possibly not as it may not be viable for them
    • if not system may collapse
34
Q

how can speculative attacks be used as an argument against fixed exchange rates?

A
  • with a fixed exchange rate there is no guarantee that the exchange rate that is decided is actually going to be the correct purchasing power value
  • may be undervalued in which case speculative attacks can destabilise the whole system is more likely
35
Q

what type of exchange rate do you tend to see?

A

you see floating exchange rates most of the time

36
Q

what does a managed floating exchange rate system allow the central bank to do

A

allows a nation’s central bank to intervene regularly in foreign exchange markets to change the direction of the currency’s float and/or reduce the amount of currency volatility

37
Q

how does depreciating the currency solve a current account deficit?

A
  • with a weak exchange rate, imports become more expensive, exports cheaper (WIDEC)
  • export revenue should in theory increase
38
Q

what does the Marshall-Lerner condition state and how can this be used to evaluate the policy of using the exchange rate to solve a current account deficit?

A

the Marshall-Lerner conditions states that a currency depreciation will only correct a current account deficit if this equation holds:
the price elasticity of demand of exports + the price elasticity for imports sum to greater than 1

39
Q

why is the marshall lerner condition important?

A
  • so if a good is elastic, if you increase the price, total revenue will fall
  • if a good is price inelastic if you increase the price, total revenue will increase
  • this applies to demand for exports and imports
40
Q

what happens if export demand is very inelastic and the currency depreciates?

A

then total export revenue will also fall

41
Q

what happens if the demand for imports is inelastic and the exchange rate depreciates?

A

imports become more expensive so price increases, total expenditure on imports will increase

42
Q

what will happen is spending on imports are high and spending on exports is low

A

will worsen the current account position

43
Q

what happens if the overall elasticity of net exports is inelastic?

A

the equation above doesnt hold as the overall elasticity is less than one

  • price of exports are falling → weaker exchange rate
  • total revenue is also falling
    this will worsen a current account deficit
    money inflows will fall
44
Q

what happens if the elasticity for net exports is greater than one?

A
  • (elastic)
    reducing the price of exports will lead to an increase in total revenue generated
  • leads to current account surplus
45
Q

in the short term, why doesnt the marshall-lerner condition hold?

A
  • in the short term demand tends to be inelastic for both imports and exports so that the total elasticity for net exports is less than 1
  • this is because consumers that tend to import take time to adust to the fact that imports are more expensive so they continue to buy/consume at the same rate as before
  • they dont understand what this depreciation means
  • also for foreign countries who may buy from e.g the UK it takes time for them to realise that their exports are cheaper
  • this leads to the J curve effect
46
Q

what is the J curve effect- draw the J curve?

A

j-curve effect- a current account will actually start to worsen before it improves because of this
only as people start to adjust to an exchange rate and reduce import expenditure, only then will their current account start to improve

47
Q

what is the relationship between interest rates and the exchange rate

A

higher interest rates offer lenders in an economy a higher return relative to other countries
higher interest rates attract foreign capital and cause the exchange rate to rise

48
Q

how does an investment affect the demand for a nation’s currency

A

households and organisations may wish to invest in UK firms (either in the form of FDI or portfolio investment) or place funds in UK banks if interest rates are attractive
this creates demand for the currency on the foreign exchange markets

49
Q

how does sale of exports affect the demand for a currency

A

exporters int he uk will expect to be paid in domestic currency
so buyers from other countries will need to sell their currency on the foreign exchange market to buy pounds

50
Q

what factors affect the supply of a currency

A

speculative purposes
to invest abroad as holders of pounds may buy shares in companies abroad
to buy imports

51
Q

what happens to the value of the domestic currency if theres an improvement in non price factors of good produced abroad

A

supply of the domestic currency increases/ shifts outwards to buy the foreign countries goods / buy imports
value of the currency decreases due to the exceess supply of the domestic currency
increases price competitiveness of domestic imports

52
Q

what are the tools for managing the floating exchange rate

A

monetary policy
buying and selling of its currency
taxing foreign investments
controls on the free flow of capital into and out of a country

53
Q

what is dirty floating/ competitive devaluation

A

when a country deliberately intervenes to drive down the value of their currency to gain an advantage in its international trade
they may also do this to attract extra FDI

54
Q

how is the floating exchange rate useful for resource allocation

A

exchange rates must be correctly valued if the worlds resources are to be allocated efficiently between competing uses
a freely floating exchange rate should respond and adjust to changes such as discovery of minerals
whereas fixed ER may be over or undervalued in favour of the country
different rates of inflation between countries mean

55
Q

how can the fixed exchange rate lead to a misallocation of resouces

A

different rates of inflation between countries mean that the fixed exchange rate leads to a misallocation of resources between economies

56
Q

what may be the effects of an appreciation of the exchange rate of a currency on current account

A

reduce demand for exports -> appear more expensive when converted into other currencies
increased demand for imports as they appear cheaper

57
Q

how can the effects of an appreciation of the exchange rate of a currency be evaluated

A

currency may not have appreciated against all currencies
currency may have appreciated against currencies of countries who dont recieve many of their exports
value of currency may change in the long term
marshall-lerner condition
J-curve effect
non price facos may be more important

[OBSELETE] S - Econ (42 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions