Exchange rates Flashcards
what causes an exchange rate to appreciate
Increased demand for the pound
1) hot money inflows
3) build factory and pay workers all in pounds not their currency
3 and 5) increase in exports
what causes an exchange rate to depreciate
increase in supply of pounds
how are fixed exchange rates maintained
to support a fixed exchange rate, the government or the central bank require large amount of currency reserves (their own and others)
or
central bank can manipulate interest rates (not as direct)
why
> counter the fluctuations of the currency
how can a country depreciate their currnecy to return back to their fixed exchange rate
by the gov or central bank selling some of the reserves and purchasing other currencies it increases the supply
supply shifts outwards and and currency depreciates
or
lower interest rates = hot money outflows
how can a country appreciate their currency to return back to their fixed exchange rate
need to increase demand so gov can buy more of the pound with their foreign currency reserves
demand shifts outwards, and currency appreciates
or
increase interest rates = hot money inflows
what are 5 reasons why the government may intervene in changing the exchange rate
how may the government intervene and change the exchange rate
purchasing power parity (PPP)
a basket of goods and services should cost the same from one currency in another currency over the exchange rate
real vs nominal exchange rate
real takes into account change in costs/prices like inflation so that is how you compare PPP
in theory nominal exchange rate should self-adjust in floating exchange rates to show PPP
this is because dollar overvalued compared to the pound
so supply of dollar increase and pound demand increases
leads to a balance (PPP)
why do exchange rates no self-adjust and remain overpowered/underpowered
due to speculation causes exchange rates to change and remain overpowered/underpowered
how does floating exchange rates automactically correct current account deficit
CA deficit = more imports than exports so the supply of the pound increases as imporiting a good exchanges the pound for the other currency so more pounds
supply shifts outwards causing a depreciation and WPIDEC
less imports more exports = improved CA deficit
EV: this is a theory and in the realword speculation is much more powerful at changing exchange rates and won’t necessarily improve CA deficit
pros for floating exchange rate
5) more likely to have PPP and stability
cons of floating exchange rates
1) volatility puts of FDI and trade
pros of fixed exchange rates
3) less costs for importers as no chance for exchange rate to change so don’t need to hedge against a currency (speculating currency may appreciate so purchase more of the currency to hedge against the rise), more money can be spend on Investment
4) cannot use exchange rates to make exporting goods more competitve, therefore need to become more efficient more competitive (increased r and d and investment)
cons of fixed exchange rates
3) no guarantee exchange rate decided is going to be correct PPP, could be over or undervalued
in the world is there more floating or fixed exchange rates
floating exchange rates majority of the time
but if the government have to intervene there is room to
what is a monetary union
a group of nations create a trading block which includes free trade of labour and capital
example:
Eurozone
3 distinct features
1) same currency
2) same monetary policy
3) same central bank
pros of monetary unions
1) for smaller nations more stability which will lead to more investment and trade
2) consumers and businesses save as the cost of converting exchange rates goes, more money to spend in economy
4) less prone to speculation, more likely a balanced PPP and currency not be under or overvalued
cons of monetary union
1) if you have a differing set of economic circumstances that would mean there is no garuntee that monetary policies set will benefit you
2) cannot boost trade performance as have no control over monetary policies
4) as they have their own control over fiscal policy if countries are risky will lead to a major burden for the rest of the nations and lead to a destabilisation
