EXCHANGE RATES Flashcards
FIXED EXCHANGE RATE
When the government or central bank set an exchange rate. Usually maintaining it at a target rate.
FLOATING EXCHANGE RATE
Free to move with changing supply or demand
MANAGED FLOATING
Left to market forces but the government will occasionally intervene to influence the exchange rate.
NOMINAL EXCHANGE RATE
An unadjusted comparison of the value of currencies
THE REAL EXCHANGE RATE
This is the nominal rate but it is adjusted to take price levels into account
BILATERAL EXCHANGE RATE
The comparison of two currencies
EFFECTIVE EXCHANGE RATE
A countries currency is compared to a basket of currencies
ADVANTAGES OF FLOATING CURRENCIES
~Don’t need currency reserves
~Can help reduces the BoP current account deficit
~Don’t need to use monetary policies eg. Monetary policy
DISADVANTAGES OF FLOATING EXCHANGE RATES
~Can fluctuate widely
~Falls in exchange rates can cause inflationary pressures
ADVANTAGES OF FIXED EXCHANGE RATES
~Speculation may be reduced
~Competitive pressures placed on firms
~Creates certainty
DISADVANTAGES OF FIXED EXCHANGE RATES
~Difficult to maintain
~They lose control of interest rates
~If speculators think it isn’t sustainable, they may decide to take advantage of selling the currency
SPECULATION DEFINITION
Where people buy and sell currency because of the changes they expect to happen in the future
THE J CURVE SHOWS THE EFFECT OF INELASTIC DEMAND ON IMPORTS AND EXPORTS
~Marshall Lerner condition might hold in the long run; therefore an improvement in the current account deficit
~However in the short run the current account deficit might worsen
~Shown on the J curve
