Exchange Rates Flashcards
What is the nominal exchange rate?
It measures the value of one currency in terms of another currency
What happens if there is no government intervention?
There would be a floating exchange rate system
What happens in a fixed exchange rate system?
The government intervenes to maintain a fixed external value or to maintain the value with a given range
What is appreciation?
Exchange rate has increased in value
What is depreciation?
Exchange rate has decreased in value
What is a floating exchange rate system?
When the exchange rate is determined by the market forces of demand for and supply of a currency
What does demand for a currency depend on?
Demand for UK products from abroad, UK interest rates, relative inflation rates and expectations
What does supply for a currency depend on?
Demand for foreign products by UK households and firms, interest rates overseas and speculation
What is the effect of an increase in demand for a currency?
Demand will shift to the right: excess in demand and the exchange rate will increase
What is the effect of an increase in supply for a currency?
Supply will shift to the right: excess of supply and the exchange rate will fall
What are the advantages of the floating exchange rate system?
Change of value reflects change of market conditions, equilibrium will be restored and no intervention cost
What are the disadvantages of the floating exchange rate system?
Difficult for firms to plan ahead if the value is changing continuously, unpredictability of the value reduces investment, speculation and equilibrium might not be reached
What is the real exchange rate?
Relative price of domestic products in terms of foreign products
What is the formula for the real exchange rate?
Nominal exchange rate x domestic price / price of foreign product
What is the purchasing power parity?
The value of a currency that gives it the same purchasing power abroad
