Exchange rates

Question 1

what causes an exchange rate to appreciate

Answer 1

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

Question 2

what causes an exchange rate to depreciate

Answer 2

increase in supply of pounds

Question 3

how are fixed exchange rates maintained

Answer 3

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

Question 4

how can a country depreciate their currnecy to return back to their fixed exchange rate

Answer 4

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

Question 5

how can a country appreciate their currency to return back to their fixed exchange rate

Answer 5

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

Question 6

what are 5 reasons why the government may intervene in changing the exchange rate

Answer 6

Question 7

how may the government intervene and change the exchange rate

Answer 7

Question 8

purchasing power parity (PPP)

Answer 8

a basket of goods and services should cost the same from one currency in another currency over the exchange rate

Question 9

real vs nominal exchange rate

Answer 9

real takes into account change in costs/prices like inflation so that is how you compare PPP

Question 10

in theory nominal exchange rate should self-adjust in floating exchange rates to show PPP

Answer 10

this is because dollar overvalued compared to the pound

so supply of dollar increase and pound demand increases

leads to a balance (PPP)

Question 11

why do exchange rates no self-adjust and remain overpowered/underpowered

Answer 11

due to speculation causes exchange rates to change and remain overpowered/underpowered

Question 12

how does floating exchange rates automactically correct current account deficit

Answer 12

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

Question 13

pros for floating exchange rate

Answer 13

5) more likely to have PPP and stability

Question 14

cons of floating exchange rates

Answer 14

1) volatility puts of FDI and trade

Question 15

pros of fixed exchange rates

Answer 15

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)

Question 16

cons of fixed exchange rates

Answer 16

3) no guarantee exchange rate decided is going to be correct PPP, could be over or undervalued

Question 17

in the world is there more floating or fixed exchange rates

Answer 17

floating exchange rates majority of the time

but if the government have to intervene there is room to

Question 18

what is a monetary union

Answer 18

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

Question 19

pros of monetary unions

Answer 19

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

Question 20

cons of monetary union

Answer 20

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