exchange rates Flashcards
definition
the rate at which one currency trades against another on the foreign exchange market
floating exchange rates
when the value of the currency is determined by market forces (supply and demand)
fixed exchange rates
when the government seeks to keep the value of the currency at a certain level
factors influencing appreciation/depreciation
economic growth
intrest rates
inflation
confidence
current account deficit/surplus
how do interest rates affect
If IR rises they can attract hot money flows
attracts more Fdi
Outwards shift in demand for currency
Currency appreciates in value
how does economic growth impact it
because markets will excepct high IR
how does a CA deficit impact it
currency will depreciate because money leaks out of the economy
appreciation of £ will lead to
uk exports more expensive
imports to the uk will be cheap
reduced inflation
lower economic growth
worsening of the CA deficit
(SPICED)
depreciation of £ will
exports more competitive
imports more expensive
increase EG
inflation will rise
3 dependent factors of exchange rates
elasticity price demand
time
strength of economy
how does demand elasticity impact exchange rate
if currency depreciates, exports quantity will increase
if demand is elastic then the depreciation will have limited impact
if price inelastic then major rise in exports
impact of time lag
in the short term the demand for goods exports is inelastic but more elastic as time goes on
strength of economy
stronger economies see the most appreciation because demand increases for exports, therefor depreciation of their currency wont decrease economic growth but may limit the growth rate
advantages of a floating exchange rate
lower exports cost, higher demand, more FDI leads to a BOP
higher market efficiency
advantages of fixed
avoids currency fluctuations
encourages firms to invest
incentive to keep inflation low
avoids devaluation
disadvantages of fixed
conflicts macro objectives
less flexible
current account imbalance
may require high IR
disadvantages of floating
fluctuations
uncertainty for importers/exporters
risk of capital flight
Depreciation currency chain of analysis/example
Recession with trading partner
Causes fall in exports
Worsening trade ballence domestically
Currency demand shifts left
Currency depreciates
How can a strong pound be negative (exporting)
Makes it expensive for exporters to sell their goods abroad
Because foreign consumers have to pay more
UK exporter COUlD lower the price but then will lose profits and make a loss
What can a strong £ cause (negative)
Unemployment
Slower economic growth
A deficit in the BOP
(Overall AD falls)
A strong pound may impact importing goods
Makes it cheaper to import raw materials or goods
Bad for businesses who compete against foreign imports
Might reduce cost push inflation
