Exchange Rates Flashcards
What are nominal exchange rates?
The rate at which one currency exchange for another
The real exchange rate
The exchange rate index adjusted for changes in the price of imports and exports
Formula for real exchange rate index
RERI=NERI x px/pm
Where px is the domestic currency price index of exports and pm is the foreign currencies weighted Price index of imports
Uses of real exchange rate
It gives us a better idea of the quantity of imports a country can obtain from selling a given quantity of exports
The real exchange rate also gives a better idea than the nominal exchange rate of how competitive a Country is
What is a fixed exchange rate
Where the government takes whatever measures are necessary to maintain the exchange rate a some stated level
Internal policy measures
What are floating exchange rates
There is no government intervention in the foreign exchange market
Exchange rates fluctuate according to market forces-According to changes in the demand and supply of currencies on the foreign exchange market
How does the central bank intervene to maintain a fixed exchange rate
Diagram Page 747
Foreign exchange market intervention and the money supply
The Rate is above equilibrium. Reduce the money supply.
The central bank with drawls money
Vice versa
Sterilisation
What is sterilisation
Where the government uses open market operations or other monetary measures to neutralise the effect of balance of payments deficit or surplus on the money supply
How does the government correct the disequilibrium
Expenditure switching method and expenditure reducing method
What is expenditure reducing
We are contractionary policies lead to a reduction in national income and hence the reduction in the demand for imports
What is expenditure switching
Where a lower exchange rate reduces the price of exports and increases the price of imports. This will increase the sale of exports and reduce the sale of imports .
How do use the government correct free Floatingexchange rates
Expenditure switching/the substitution effect
Expenditure changing/the income effect
Effectiveness
A rise in national income and employment but no change in prices/
rise in price
Adjustable peg
A system where by exchange rates are fixed for a-period of time but may be devalued if a deficit becomes substantial/revalued if a surplus becomes substantial
Managed floating
It’s a system of flexible exchange rates but where the government intervenes to prevent excessive fluctuations or even to achieve and unofficial target exchange rate
Crawling peg
Half between managed floating and the adjustable peg
The government adjust the peg by small amounts but frequently
