Exchange Rates

Question 1

Exchange rates

Answer 1

The price of a nations currency in terms of another currency

Question 2

Factors affecting exchange rates (6)

Answer 2

Net trade
IR: hot money flows
Price level
Speculation
EG/events
Y: Income (MPI)

Question 3

Floating exchange rate

Answer 3

Currency value is set by market forces and there is no intervention by the central bank. There’s no target for the exchange rate.

Question 4

How an appreciation in the exchange rate occurs

Answer 4

• Hot money flows
• increased demand for pounds
• Price then increases

Question 5

How an appreciation of an exchange rate can affect

Answer 5

N: increase in X and fall in M
IR is increased
Price level falls
Speculation is positive
EG/Events are positive
Y falls: MPI

Question 6

How a depreciation of the exchange rate can occur

Answer 6

• Brexit: recession fears
• Speculation of low IR
• Selling of pounds
• Increase in supply
• Fall in the price of the pound

Question 7

Depreciation of exchange rate how it affects NIPSEY

Answer 7

N: increase in M, decrease in X
IR low
Price level high
Speculation is negative
Events/EG are negative
Y- income increases (MPI)

Question 8

Impact of depreciating currency on inflation

Answer 8

Increasing import prices could increase the PL for consumers

Question 9

Impact of depreciating currency on EG

Answer 9

Stimulus for EG as net exports will increase

Question 10

Depreciating exchange rate affect on UE

Answer 10

• Competitive currency: increases domestic consumption
• Possible multiplier effect: more tourism and foreign students

Question 11

Depreciating exchange rate affect on BOP

Answer 11

Usually good but it depends on the PED for exports. There could be a possible J-Curve effect.

Question 12

Depreciating currency affect in business investment

Answer 12

Increased profitability because overseas earnings will be worth more in terms of pounds

Question 13

J-Curve effect

Answer 13

• Currency depreciation
• Should see a fall in imports but first the situation gets worse before contracts have to be fulfilled
• LT trade position improves

Question 14

Marshall Lerner condition

Answer 14

A depreciation of exchange rates will lead to an increase in net trade balance if PED for X+M is greater than 1

Question 15

Evaluation of currency depreciation

Answer 15

• The scale of the change in the exchange rate (5%,10%, 15%)
• Change LT or ST?
• When currency movement takes place: recession/recovery/boom

Question 16

Floating exchange rates advantages (3)

Answer 16

• Little reserve holding required
• Can set IR to meet domestic objectives
• Partial autocorrection for current account deficit

Question 17

Floating exchange rate disadvantages (2)

Answer 17

• No guarantee of stability
• Volatility may scare investors

Question 18

Fixed exchange rates

Answer 18

Government/central bank fixes the value. The pegged exchange rate becomes the official rate and is adjustable

Question 19

Fixed exchange rate advantages (4)

Answer 19

• Certainty of value: attracts investment
• Export dependant economies may favour managed system due to less volatility (China)
• Stability helps control inflation: discipline to keep unit costs low
• Imposes macro responsibility on gov/central bank

Question 20

Fixed exchange rate disadvantages (3)

Answer 20

• Reduced freedom to use IR for other MEPOs
• Requires large reserves some countries are unable to hold
• Devaluation of fixed exchange rate can lead to cost push inflation