Exchange Rates

Question 1

What is a fixed exchange rate?

Answer 1

When the price of a country’s currency is pegged against another. Can either be devalued or revalued.
Examples= Saudi Arabia, Denmark, Bulgaria

Question 2

What is a floating exchange rate?

Answer 2

When the price of a country’s currency is determined by market forces. Can either appreciate or depreciate.
Examples= UK, Aus dollar, New Z dollar
Closest to “pure” floating= Canada

Question 3

What is a managed/dirty float?

Answer 3

When a currency is free to fluctuate between ceiling and floor; if moves outside, Gov/BoE will intervene by buying and reserving or selling currency.

Question 4

What effects the demand for a currency?

Answer 4

Demand= exports+hot money (interest rates)
•as exchange rate falls, exports become cheaper=more competitive
•increases demand for exports (thus currency)
•causing an appreciation

Question 5

What effects the supply of a currency?

Answer 5

Supply= imports
•a country will buy foreign currencies in exchange for theirs on the foreign exchange market
•allows them to import goods/services
•therefore they increase the supply of their currency in exchange for a good/service
•consumers buy more imports
•causes a depreciation

Question 6

What 3 key factors effect exchange rates?

Answer 6

1. Government debt= if markets fear a Gov may be unable to repay debt, investors will sell their bonds which depreciates exch rate
2. Inflation= higher prices reduce UKs export demand (and so currency) causing depreciation; countries with low inflation rates tend to see an appreciation
3. Interest rates= if IR high relative to elsewhere, will be more attractive to deposit money so will cause an appreciation

Question 7

Pros and cons of floating exchange rates?

Answer 7

PROs:
•BoP equilibrium= should self-correct, e.g deficit should cause depreciation
•resource allocation= allows for efficient resource allocation in competitive market where demand is ever-changing

CONs:
•assumes not to be effected by speculation= irl hot money (speculation) has great influence
•domestic inflation= if depreciates, increase imports which causes cost-push inflation; if appreciates, AD increases which causes demand-pull

Question 8

Pros and cons of a fixed exchange rate?

Answer 8

PROs:
•stability+certainty= higher private investment?
•anti-inflationary tool

CONs:
•discourages FDI
•possible BoP deficit or currency crisis if currency is overvalued

Question 9

What is the definition?

Answer 9

The price of one currency in terms of another.