Exchange Rates Flashcards
Define Exchange Rates
Exchange rate is simply the value of a currency in terms of what it can buy of other currencies
What is the acronym for a weaker currency
WPIDEC (weaker pound imports dearer exports cheaper)
What is the acronym for a stronger currency
SPICED (strong pound imports cheaper exports dearer)
Define hot money
Hot money flows refer to capital flows moving to countries with higher interest rates and/or expected changes in exchange rates.
What is the floating exchange rate
A floating exchange rate occurs when governments allow the exchange rate to be determined by market forces and there is no attempt to influence the exchange rate.
What is the floating exchange rate determined on
Demand: The people who demand pounds are foreign firms who want to buy British goods or foreign tourists who want to go on holiday here.
Supply: Usually banks or other financial institutions hold stocks of UK pounds and sell them to those who want to buy them.
Factors influencing demand for the pound to rise
UK goods/services become more desirable for foreign consumers to purchase
UK interest rates rise in relation to interest rates in foreign banks attracting hot money
People think that pound will rise in the future – speculate by buying pounds (caused by political factors)
Factors influencing supply for the pound rise
Overseas interest rates rise – People sell their pounds to buy foreign currency
Overseas goods are demanded more
People think the pound will fall in the future.
What happens to economic growth and unemployment when the pound falls
A Rise in growth rate as rise in exports, fall in imports
Will improve manufacturing firms price competitiveness in domestic and foreign markets > rise in output.
Fall in unemployment more workers needed to produce more output to serve export and domestic markets
May lead to a rise in Foreign direct investment, foreign firms relocate to UK – capital injection.
what happens to consumers when the pound falls
Negative – Face higher priced imports & more expensive foreign holidays
Positive - May find jobs in firms increasing output to serve export & domestic markets
What happens to inflation when the pound falls
Fall in pound can lead to cost push inflation due to higher import prices
Workers may demand higher wages due to rise in inflation.
What happens to exports and imports when the pound falls
Exports – Fall in pound makes goods more price competitive, demand will be higher if goods are price elastic
Imports – Demand for imports will fall as they become more expensive.
If inelastic paying more for goods, firms rely on imports for materials.
What happens to the balance of payments
Improved current account balance as
Exports rise and imports fall pushes AD to the right
What do the effects of a falling pound depend on
All depends
How much X and M respond to price changes (are firms ready to have improved price competitiveness)
Whether the other components of AD are changing or not
Size of depreciation and how long it lasts
Depends against what currency the pound depreciated against (are they uk export markets)
What are the disadvantages of a fall in the pound (depreciation)
A weak currency can make it harder for the government to finance a budget deficit and oversea deficits.
Depreciation increases cost of imports this is good but bad as we still need to import essential food and raw materials.
Also the “J curve effect”
