EXCHANGE RATES Flashcards
What is an Exchange Rate?
The rate at which one currency can be exchanged for another
What are the Axes labelled on an ER Diagram?
Y-Axis - Exchange Rate
X-Axis - Quantity of Currency
Factors Affecting Exchange Rates
- Imports and Exports (net balance of trade)
- Speculation
- Relative Interest Rates
- Relative Inflation Rates
- FDI
- Quantitative Easing
How Do Exports affect Exchange Rates?
- More Exports - More people wanting to convert to £s - Demand for £ increases (Right Shift) - Exchange Rate decreases
- Less Exports - Less people wanting to convert £s - Demand for £ decreases (Left Shift) - Exchange Rate increases
How do Imports affect Exchange Rates?
- More Imports - More people selling £s - Supply of £s increases (Right Shift) - Exchange Rate Decreases
- Less Imports - Less people selling £s - Supply of £s decreases (Left Shift) - Exchange Rate Increases
How does Speculation affect Exchange Rates?
- Speculation over future exchange rates will affect exchange rates now
- People/Investors will act now in anticipation of future changes which will end up affecting current ERs
- E.g. People may predict a depreciation in ER in 4 MONTHS time so will sell off currency NOW, increasing Supply of Currency and Decreasing the ER NOW (not up to point expected in 4 months though)
How do Relative Interest Rates affect Exchange Rates?
HOT MONEY FLOWS; E.g. UK
- IR in UK Increases - Hot Money Flows into the UK as Investors wish to save in UK for higher reward on savings - Demand for £s increases (Right Shift) - ER Increases
- IR decreases - Hot Money Flows out of the UK as Investors wish to save money elsewhere for higher reward - Supply of £s increases (Right Shift) - ER decreases
How do Relative Inflation Rates affect Exchange Rates?
- Lower Inflation Rate means Appreciation in Currency
- If the Inflation Rate is higher in Country A than B, that Country A’s prices are increasing faster than B; making Country B’s good more internationally competitive - Exports from B increase - Demand for Currency B increases (Right Shift) - ER Increases
How does FDI affect Exchange Rates?
- More FDI means Appreciation in Currency
- More FDI into UK means Foreign Investors would be forced to exchange their currency to the currency of the UK - Demand for £s increases (Right Shift) - ER Increases
- Opposite is also True
How does Quantitative Easing affect Exchange Rates?
- More QE means Depreciation in Currency
- More QE would mean increased Creation of Money - Supply of £s increases (Right Shift) - ER decreases
Impacts on a Country of Changes to their Exchange Rate
- Growth and Employment
- Inflation rate
- FDI flows
- Current Account
Effect of ER on Growth and Employment
- ER Increase - Growth and Employment Decrease
- Decreased ER - WPIEEC so increased AD; “X(up) - M(down)” - AD Shift Right - Increase in RNO and Economic Growth - Increase in Derived Demand for Labour and Decrease in Cyclical Unemployment
- However, could make it more Expensive to Import Raw Materials - Costs of Production increase - SRAS Decrease (Left Shift) and counteracting effects on Growth and Employment
- Opposite is also True
Effect of ER on Inflation
- Decreased ER - WPIEEC so Less Imports and More Exports which increases AD (X-M) - AD Shift Right - Price Level Increase; Demand Pull Inflation
- Could also make it more Expensive to Import Raw Materials for Production - Costs of Production increase - SRAS Decrease (Left Shift) - Price Level Increase ; Cost-Push Inflation (Imported Inflation)
- Opposite is also True
Effect of ER on FDI
Effect of ER on Current Account