Exchange Rates Flashcards
What does the XR measure
The external value of one currency against another currency
What is the value of the currency determined in
The foreign exchange market where billions of dollars of currencies are traded every hour
What are the main currency traders
Businesses, international investors and governments
What is a floating exchange rate
An exchange rate system where the forces of market demand and supply determine the daily value of one currency against another
What XR system is the UK
Floating XR system
What does the value of the pound depend on
How strong demand for the currency is for the currency relative to supply
How overseas investors link to XR when banking in the U.K.
If overseas investors want to buy sterling to take advantage of higher interest rates on offer in UK bank accounts, they will swap their own currencies for pounds = increases demand for sterling = appreciation
Causes of a currency appreciation
- large trade surplus
- when overseas investors regard the currency as a good one to buy
- high expected returns from other types of investment notably property, stocks and shares so on.
What does a change in the XR influence the economy through
Demand for imports and exports, real GDP growth, inflation, business profits and jobs
What does the impact of movements in currencies on the economy depend part on
- scale of change
- time of change- short or long term
- how businesses and consumers respond
- size of any multiplier and accelerator effects
- when the currency movement takes place
What happens when the pound depreciates against the US dollar
It makes UK import prices rise. It makes UK export rises fall.
How does the XR affect the rate of inflation
- changes in the prices of imports
- commodity prices
- changes in the growth of U.K. exports
How is the XR affected by changes in the prices of imports
E.g. appreciation of the XR usually reduces the sterling price of imported consumer goods and durables, raw materials and capital goods
How is the XR affected by commodity prices
A stronger dollar makes it more expensive for Britain to import these items.
How is the XR affected by changes in the growth of U.K. exports
A higher XR makes it harder to sell overseas because of a rise in relative UK prices
What does the Marshall Lerner condition state
That a depreciation / devaluation of the XR will lead to a net improvement in the trade balance, provided that the sum of the PED for exports and imports > 1.
Evaluation points on the effects of XR changes
- counter-balancing use of fiscal and monetary policy
- time lags
- low PED
- business response to the challenge of a high XR
How might businesses relating to a high XR
- cutting export prices
- out-sourcing components from overseas to keep production costs down
- seeking productivity / efficiency gains
- investing extra resources in new product lines
Process of currency appreciation and the demand for imports
Appreciation of currency = rise in external purchasing power = cheaper to import goods and services = rising demand for imports = worsening of the trade balance = fall in AD