Exchange Rates

Question 1

What are exchange rates

Answer 1

The price of one currency in terms of another

Question 2

What is a currency

Answer 2

System of payment adopted by a country

Question 3

2 categories of exchange rate system

Answer 3

fixed exchange rate

floating exchange rate

Question 4

what is a fixed exchange rate

Answer 4

is fixed against either the value of another currency or to a measure of value (gold)

Question 5

what is a floating exchange rate

Answer 5

where the value of a currency is determined by the forces of demand and supply
(currencies bought and sold on FOREX)

Question 6

what is the demand for currencies based upon

Answer 6

exports demand
inflows of investment
speculative buying (hot money)
central bank buying up their own currency

Question 7

what is the supply of currencies based upon

Answer 7

demand for imports
outflows of investment
speculative selling
central bank selling their own currency

Question 8

what is hot money

Answer 8

capital flows moving to countries with higher interest rates or expected changes in exchange rates

Question 9

what could a country do to fix the exchange rate in relation to another currency

Answer 9

lower interest rates (hot money leaves)
Buy the other country’s currency
limit the other country’s investment into their country to lower demand for their currency

Question 10

4 measures of exchange rates

Answer 10

bilateral exchange rates
effective exchange rates
nominal exchange rates
the real exchange rate

Question 11

what is the bilateral exchange rate

Answer 11

measuring 1 currency against 1 other

Question 12

what is the effective exchange rate

Answer 12

describes the strength of a currency relative to a basket of other currencies

Question 13

what is the nominal exchange rate

Answer 13

the number of units of the domestic currency that are needed to purchase a unit of a given foreign currency

Question 14

what is the real exchange rate

Answer 14

tells you how much the goods and services in the domestic currency can be exchanged for the goods and services in a foreign country

Question 15

what is the purchasing power parity

Answer 15

in the long run, exchange rates between countries should even out so that goods essentially cost the same in both countries

Question 16

what are the 3 exchange rate systems

Answer 16

freely floating
fixed exchange rate
a hybrid system

Question 17

what is a freely floating exchange rate system

Answer 17

the exchange rates move freely and are solely determined by changing supply and demand for the currency

Question 18

what is a fixed exchange rate system

Answer 18

the government or the central bank sets the exchange rate- involves maintaining the rate at a set target

Question 19

what are the hybrid exchange rate systems

Answer 19

managed floating
semi-fixed
pegged

Question 20

what is a managed floating exchange rate system

Answer 20

floating system, but the government occasionally intervenes to influence the rate

Question 21

what is a semi-fixed exchange rate system

Answer 21

more like fixed, but a small degree of float is allowed between an upper and lower band of the currency

Question 22

what is a pegged exchange rate system

Answer 22

the value of a currency is pegged to another currency, (euro or US$)

Question 23

what happens if equilibrium is above the fixed rate- a shortage of the national currency

Answer 23

Gov would intervene: sell their own currency and buy overseas currencies instead- shifting supply curve right, and foreign currency holdings will rise

Question 24

what happens if the equilibrium is below the fixed rate- a surplus of the national currency

Answer 24

Gov buys their own currency by selling foreign currency reserves- this boosts demand for their own currency shifting D right

Question 25

evaluate fixed exchange rates

Answer 25

greater certainty, less speculative activity, cause firms to keep costs low, keeps inflation low, lowers interest rates, stimulates trade and investment

can be fragile, and wilt under pressure, inflexible so cant be a natural stabiliser

Question 26

evaluate floating exchange rate

Answer 26

natural stabiliser, gov has flexibility so can deal with economic shocks more effectively

uncertainty, lack of economic discipline

Question 27

how do exchange rates ensure competitiveness

Answer 27

affects AD
can be manipulated
rates need to be held down to stimulate exports and pushed up to reduce inflationary pressure

Question 28

consequences of devaluation

Answer 28

raise AD
increase GDP
create jobs
lead to improvement in BOP

Question 29

consequences of revaluation

Answer 29

reduce excessive AD
keep inflation down
export sector may suffer
jobs lost

Question 30

consequences in fluctuations

Answer 30

SPICED, WPIDEC- competitiveness and effect on inflation
uncertainty
effect on RDI