Exchange Rates 🧟♀️ Flashcards
How can you measure exchange rates?
- nominal exchange rate
- real exchange rate
- bilateral exchange rate
- effective exchange rate
What is nominal exchange rate
- direct comparison of currencies
What is real exchange rate
- adjusts nominal ExR to take price levels into account - shows true value of currency
What is bilateral exchange rate
- ExR between two countries
- e.g £:$
What is an effective exchange rate
An ExR measured against a basket of currencies of trading partners
- weigh each country by the proportion of your trade you do with it
- gives an overall summary of the value you of currency against others
What is an adjustable peg?
- fixed in the short term but regularly adjusted to a new fixed rate
What is a crawling peg?
- fixed but regular small adjustments to fixed rate
What is a managed float
- Floating but central bank intervenes to avoid large fluctuations
What is a managed float
- Floating but central bank intervenes to avoid large fluctuations
Exchange rate band systems
- free float with a permitted band, intervention takes place if ceiling or floor is reached
What is a free floating exchange rate?
Value of one currency in terms of another is determined without interference; it is determined by the forces of demand and supply
- trade flows and capital flows affect the exchange rate
- no target exchange rate
- no need for official intervention in the currency market by central bank
What determines the demand of the £?
- Speculation on the future of value of the £
- Interest rates
- FDI inflows
- Exports
- Government ‘open market’ operations (selling forex reserves and buying £s) in the FOREX market
- Inflation rates (demand for exports)
What may cause short run buying of £?
Speculation that £ will rise
What may cause long run buying of £s?
- hot money inflows (UK interest rates are rising)
- FDI rising
What may cause an increase in exports (irrelevant to exchange rate)
- derived demand
What are the 5 main arguments for a floating exchange rate?
- Reduced need for currency reserves
- Useful instrument of macroeconomic adjustment
- Partial automatic correction for a trade deficit (however, dependent on J curve)
- Reduced risk of currency speculation
- Freedom for domestic monetary policy
Why is it good to have a reduced need for currency reserves?
- little requirement for central bank to hold large scale reserves of foreign currency to use in possible intervention in the markets