Exchange Rates

Question 1

What effects does an increase in inflation have on exchange rates?

Answer 1

Causes a depreciation due to PPP

Question 2

What impact does a depreciation in the exchange rate have on imports and exports?

Answer 2

Stimulated exports and makes imports more expensive

Question 3

What impact does an appreciation in the exchange rate have on imports and exports

Answer 3

Decrease exports and increase imports as they become relatively cheaper

Question 4

What factors influence the exchange rate? (8)

Answer 4

1. Inflation - low inflation = appreciation
2. Interest rates - high r/i = appreciation
3. Speculation - if anticipation of a rise in r/e in future, there will be demand which will cause an r/e apprecitation
4. Change in competitiveness - more competitive = appreciation
5. Relative strength of other currency
6. Balance of payments - deficit can cause depreciation
7. Government debt - if investors thing govt will default on debt, they will sell bonds which can depreciate the r/e
8. Govt intervention - influencing r/e

Question 5

What is a floating exchange rate?

Answer 5

Where the government doesn’t intervene and the r/e is determined by market forces

Question 6

What is a fixed exchange rate?

Answer 6

Where a government intervenes to try and keep the value of the currency at a certain level against other currencies

Question 7

What are the 4 benefits of a fixed exchange rate?

Answer 7

1. Avoid currency fluctuations which can help stabilize trade
2. Stability encourages investment
3. Keep inflation low
4. Can help stabilize the current account

Question 8

What are the 7 negatives of a fixed exchange rate?

Answer 8

1. Conflict with other macro objectives
2. Less flexibility to respond to temporary shocks
3. Can join at the wrong rate - if too high exports will be uncompetitive
4. Requires high interest rates
5. Current account imbalances e.g. from an overvalued r/e
6. Difficulty in keeping the value of the currency
7. Can encourage speculative attacks