Exchange Rates Flashcards
What are the effects of an appreciation and depreciation in the Pound for imports and exports
Appreciation:
-Imports are cheaper for domestic consumers
-Exports are more expensive for foreign consumers
Depreciation:
-Imports are more expensive for domestic consumers
-Exports are cheaper for foreign consumers
What are the factors affecting exchange rates
-Imports and exports
-Speculation
-Relative interest rates
-Relative inflation rates
-FDI
-Quantitative easing
How do imports and exports affect exchange rates
If imports decrease, the supply of pounds will decrease, leading to an appreciation in the exchange rate and vice versa
If exports increase, the demand for pounds will increase, leading to an appreciation in the exchange rate and vice versa
Imports affects the … curve
And exports affects the … curve
- Supply
- Demand
What is speculation and how does it affect exchange rates
Speculation is when investors predict changes in a currency’s exchange rate to make a
profit (buy low,sell high)
If you predict that exports will increase in the future,then demand will increase,meaning that investors will buy more pounds now and sell more later.
How do relative interest rates affect exchange rates?
When interest rates increase,more hot money inflows into the country,meaning that investors have to buy more pounds,increasing demand for pounds,causing a appreciation in the exchane rates and vice versa
What are hot money flows
When an increase in domestic interest rates causes foreigners to deposit money in domestic bank account, increasing the demand for domestic currency, causing an appreciation
What is the Marshall Lerner condition
If the combined PED of imports and exports is greater than 1, a depreciation in the currency will improve the current account deficit.
What is a free floating exchange rate system
Where the value of a currency is PURELY determined by the market’s supply and demand for that currency with no official intervention in the currency market
What is a managed floating exchange rate system
Where the value of a currency is determined by the market’s supply and demand for that currency by the Central Bank will try to prevent large changes in the exchange rate on a daily basis
What is a fixed exchange rate system
When a government sets their currency against another and that exchange rate doesn’t change.
What is the difference between depreciation and devaluation
Depreciation is a fall in the value of the currency in a free floating exchange rate system
Devaluation is when a government purposefully intervenes to drive down the value of their currency.
Go on sketchpad and draw the J-curve for a depreciation in the UK currency
Did you remember:
1.Current account surplus on the positive y-axis
2.Current account deficit on the negative y-axis
3.Time on the x axis
4. Decreases first below the axis axis
5. Then increases above the x axis
6. The curve should look like the letter “J”
Why is the J curve for a depreciation the UK currency shaped like that?
When the pound depreciates, people will not immediately recognise that UK exports are cheaper and it will take some time to find a source for them, whilst UK consumers will not see that imports are more expensive and may be unable to switch right away.
This is mainly due to demand being inelastic in the short run, which is why the curve decreases initially
However, in the long run, consumers will have time to find alternatives which is the curve then increases.
