exchange rates Flashcards
exchange rate
the value of one currency against another
three types of exchange rates
- fixed
- floating
- managed floating
how a lower currency can affect macro objectives?
- exports competitive so stronger tarde balance
- increased employment
- inflation will rise as imports are more expensive
- less sustainable
the effects of a change in exchange rates will depend on…
- length of time lags as consumers/businesses respond
- magnitude of change
- whether the change is short or long term
- size of multiplier
- which stage of economic cycle ?
currency appreciation leads to..
- BoP worsens
- unemployment increases as firms produce less
- less growth
- more sustainable
- inflation will fall
advantages of fixed exchange rate
- provides currency stability which encourages investment
- can avoid inflation
- no hedging currency risk
- lower borrowing costs (lower bond yields)
- can put pressure on firms to remain productive as they cannot rely on exchange rates to be competitive
advantages of floating exchange rate
- may help prevent imported inflation
- reduces need for foreign currency reserves
- freedom to set domestic interest rates to meet objectives
- partial auto correction for current account deficit
- insulation for an economy after external shock
3 countries using managed floating
- China
- Switzerland
- Ghana
how do interest rates affect the exchange rate?
- higher interest rates cause demand for currency to increase
- hot money flows from abroad as people want to gain interest
how does portfolio investment affect the exchange rate?
strong flows of investment cause a currency to appreciate (investors inject money into shares/bonds/ property)
how does FDI affect the exchange rate?
when foreign firms set up in the UK it causes the demand for the pound to increase
how do trade balances affect the exchange rate?
- currency appreciates if money flows into circular flow of income due to exports
- exports increasing means mored demand for £
- deficit = depreciation
Marshall Lerner condition
- predicts circumstances in which a fall in exchange rate improves current account of BoP
- devaluation only improves BoP if the sum of price elasticities of imports and exports is greater than 1
public sector spending:
- capital expenditure
new public infrastructure (new motorways, NHS buildings, schools)
public sector spending:
- current expenditure
on providing public services (healthcare, education)
