Exchange Rates

Question 1

What does the XR measure

Answer 1

The external value of one currency against another currency

Question 2

What is the value of the currency determined in

Answer 2

The foreign exchange market where billions of dollars of currencies are traded every hour

Question 3

What are the main currency traders

Answer 3

Businesses, international investors and governments

Question 4

What is a floating exchange rate

Answer 4

An exchange rate system where the forces of market demand and supply determine the daily value of one currency against another

Question 5

What XR system is the UK

Answer 5

Floating XR system

Question 6

What does the value of the pound depend on

Answer 6

How strong demand for the currency is for the currency relative to supply

Question 7

How overseas investors link to XR when banking in the U.K.

Answer 7

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

Question 8

Causes of a currency appreciation

Answer 8

• 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.

Question 9

What does a change in the XR influence the economy through

Answer 9

Demand for imports and exports, real GDP growth, inflation, business profits and jobs

Question 10

What does the impact of movements in currencies on the economy depend part on

Answer 10

• 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

Question 11

What happens when the pound depreciates against the US dollar

Answer 11

It makes UK import prices rise. It makes UK export rises fall.

Question 12

How does the XR affect the rate of inflation

Answer 12

• changes in the prices of imports
• commodity prices
• changes in the growth of U.K. exports

Question 13

How is the XR affected by changes in the prices of imports

Answer 13

E.g. appreciation of the XR usually reduces the sterling price of imported consumer goods and durables, raw materials and capital goods

Question 14

How is the XR affected by commodity prices

Answer 14

A stronger dollar makes it more expensive for Britain to import these items.

Question 15

How is the XR affected by changes in the growth of U.K. exports

Answer 15

A higher XR makes it harder to sell overseas because of a rise in relative UK prices

Question 16

What does the Marshall Lerner condition state

Answer 16

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.

Question 17

Evaluation points on the effects of XR changes

Answer 17

• counter-balancing use of fiscal and monetary policy
• time lags
• low PED
• business response to the challenge of a high XR

Question 18

How might businesses relating to a high XR

Answer 18

• cutting export prices
• out-sourcing components from overseas to keep production costs down
• seeking productivity / efficiency gains
• investing extra resources in new product lines

Question 19

Process of currency appreciation and the demand for imports

Answer 19

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