Exchange rates

Question 1

exchange rate d

Answer 1

the price of one currency in terms of another

Question 2

what does an increase in UK exports to the US do to the demand for dollars and pounds

Answer 2

increase demand for pounds

increase supply of dollars

Question 3

appreciated d

Answer 3

when a floating currency increases in value

Question 4

depreciated d

Answer 4

when a floating currency decreases in value

Question 5

advantages of floating exchange rate

Answer 5

continuous and automatic adjustment (to reflect purchasing powers)
reduced speculative pressure (speculators have less control)
reduces need for government to hold large reserves

Question 6

disadvantages of floating exchange rate

Answer 6

no guarantee that allowing it to float will solve BOP problems
effect on inflation
uncertainty

Question 7

what are the factors that affect exchange rates

Answer 7

relative interest rates
inflation
FDI and trade and current account deficits

Question 8

what do interest rates do to the exchange rate

Answer 8

‘hot money’ flows from companies and rich individuals move around the world seeking the highest interest rates

Question 9

say inflation in the UK is higher than in the US, what happens

Answer 9

UK goods more expensive so fall in US demand (supply of dollars to the left)
US goods appear cheaper so demand increases (demand for dollars to the right)

Question 10

what is the effect of inflation on the exchange rate

Answer 10

depreciation because UK goods more expensive so less demand for pounds
UK consumers want to buy more imports (increase supply of pounds)

Question 11

what is the effect of FDI on the exchange rate

Answer 11

increase demand for a currency which will lead to an increase in its value

Question 12

what is the effect of trade and current account deficits on the exchange rate

Answer 12

countries with deficit supply more of their currency in relation to the demand for it
speculators may transfer out if persistent deficit

Question 13

problem with fixed exchange rate

Answer 13

need periodic revision (countries grow at different rates),
may have to run deflationary (harm growth),
vulnerable to speculation

Question 14

what would the authorities do in fixed exchange rate if the demand for dollars exceeded supply

Answer 14

could abandon fixed rate
restrict demand for dollars
increase in taxation
increase interest rate

Question 15

advantages of fixed exchange rates

Answer 15

increased certainty for businesses
seen as a way of controlling inflation
fixed rates lead to orderly international currencies resulting in price stability and increased trade

Question 16

disadvantages of fixed exchange rate

Answer 16

need periodic revision as countries grow at different rates
reduce country’s growth (may need to run a deflationary policy to maintain exchange rate)
speculation

Question 17

what is a managed float

Answer 17

where the sterling is free to fluctuate between undisclosed levels

Question 18

why would an economy use a managed float

Answer 18

to obtain the advantages of both floating and fixed exchange rates

Question 19

dirty float d

Answer 19

manipulation of a floating rate to gain advantages over trading partners

Question 20

what are the maximum and minimum price levels called in a managed float

Answer 20

ceiling price

floor price