Exchange rates

Question 1

What is a fixed exchange rate

Answer 1

Government or central bank sets the exchange rate and maintains it at a target

Question 2

what is a floating exchange rate

Answer 2

Free to move with the changing of supply and demand of a currency

Question 3

Managed floating

Answer 3

Exchange rate is left to market forces but government will occasionally intervene when necessary

Question 4

semi fixed exchange rate

Answer 4

Exchange rate is only allowed to fluctuate within set band

Question 5

pegged exchange rate

Answer 5

value of a currency is pegged to another currency and can move periodically

Question 6

examples of each exchange rate

Answer 6

Managed floating - Japan
Fixed - Saudi Arabia
Floating - UK
Semi fixed - Nigeria
Pegged - Lebanon

Question 7

What exchange rate does devaluation and revaluation refer to

Answer 7

Fixed

Question 8

What exchange rate does appreciate and depreciate refer to

Answer 8

Floating

Question 9

Advantages of Floating

Answer 9

• 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

Question 10

Disadvantages of Floating

Answer 10

• 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

Question 11

Advantages of fixed exchange rate

Answer 11

• 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

Question 12

Disadvantages of a fixed exchange rate

Answer 12

• 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

Question 13

What is competitive devaluation and depreciation

Answer 13

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

Question 14

What are the influences on floating exchange rates

Answer 14

Basic supply and demand theory

Question 15

What are supply and demand fluctuations on the exchange rate caused by

Answer 15

• 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

Question 16

Marshall Lerner condition

Answer 16

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

Question 17

J-Curve what is the x and y axis

Answer 17

x axis - time
y axis - surplus and deficit

Question 18

What does the J curve show

Answer 18

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

Question 19

Impacts of a fall in the value of a currency

Answer 19

• 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

Question 20

Impacts of a rise in the value of a currency

Answer 20

• Unemployment may rise as growth and output will drop
• worsen the BoP
• Can reduce import prices so help inflation
• Increase FDI flows