Exchange rates Flashcards
What is a fixed exchange rate
Government or central bank sets the exchange rate and maintains it at a target
what is a floating exchange rate
Free to move with the changing of supply and demand of a currency
Managed floating
Exchange rate is left to market forces but government will occasionally intervene when necessary
semi fixed exchange rate
Exchange rate is only allowed to fluctuate within set band
pegged exchange rate
value of a currency is pegged to another currency and can move periodically
examples of each exchange rate
Managed floating - Japan
Fixed - Saudi Arabia
Floating - UK
Semi fixed - Nigeria
Pegged - Lebanon
What exchange rate does devaluation and revaluation refer to
Fixed
What exchange rate does appreciate and depreciate refer to
Floating
Advantages of Floating
- Reduces need for currency reserves
- Can help to automatically reduce a current account deficit
- Monetary policy isn’t needed to maintain the exchange rate
- Can absorb economic shocks
Disadvantages of Floating
- Can fluctuate making planning difficult
- speculation can artificially strengthen an exchange rate causing exports to fall
- Exchange rate falls can be inflationary especially if import demand is inelastic
Advantages of fixed exchange rate
- speculation is reduced
- competitive pressures are placed on firms to keep costs down and be productive
- encourages FDI as it is stable
- Businesses can plan long term
- less money spent on hedging
- good for countrys with volatile commodity exports
Disadvantages of a fixed exchange rate
- difficult to maintain
- the country loses control of interest rates for other objectives as they must be maintained for exchange rate
- must have huge foreign currency reserves
- Must be managed effectively
What is competitive devaluation and depreciation
This is done to improve the BoP by reducing price of exports to make them more desirable and increasing price of imports to reduce demand for them
–> can be inflationary
What are the influences on floating exchange rates
Basic supply and demand theory
What are supply and demand fluctuations on the exchange rate caused by
- Speculation buying and selling
- Central bank buying and selling
- If inflation is high then imports become cheaper and exports more expensive which reduces demand for domestic currency
- High interest rates increase demand with inflow of hot money
- greater confidence in economy creates greater demand for its currency
- current account deficit means high supply of currency due to purchase of imports
Marshall Lerner condition
For a fall in the value of a currency to lead to an improvement on the balance of payments, the PED for imports and exports added together must be greater than one
J-Curve what is the x and y axis
x axis - time
y axis - surplus and deficit
What does the J curve show
In the short run a depreciation won’t improve the deficit because demand for imports and exports will be inelastic but in the long run alternatives can be found and the debit will improve
Impacts of a fall in the value of a currency
- Economic growth increase as exports has increased
- Unemployment will be reduced due to growth increasing
- Inflation may rise in import demand is inelastic
- increased import prices can cause cost push inflation as cost of production materials will rise
- FDI rises as the cost is lower and economy prospects are better as growth has increased
Impacts of a rise in the value of a currency
- Unemployment may rise as growth and output will drop
- worsen the BoP
- Can reduce import prices so help inflation
- Increase FDI flows
