Exchange rates

Question 1

Exchange rates

Answer 1

One currency against another

Question 2

Spot exchange rate

Answer 2

The rate for a currency at today’s market price

Question 3

Floating exchange rate

Answer 3

When the demand increases, value increases (appreciate) & vice versa
When supply increases, value decreases (depreciate) & vice versa

Question 4

Forward exchange rate

Answer 4

The delivery of a currency at a specified time in the future at an agreed rate
Companies wanting to reduce risks from exchange rate volatility can buy their currency ‘forward on the market’

Question 5

Factors influencing exchange rates

Answer 5

Trade balances, FDI, portfolio Investment, interest rate differentials

Question 6

Arguments for a floating exchange rate

Answer 6

Reduced need for currency reserves
Useful instrument for economic adjustment
Partial automatic correction for trade deficit
Less opportunity for currency speculation
Freedom (autonomy) for domestic monetary policy
Help to prevent imported inflation
Less risk of speculative attacks

Question 7

Automatic stabilisers

Answer 7

Policies that naturally kick in to stop the economy/ exchange rate going off course

Question 8

Problems with floating exchange rate

Answer 8

Can be volatile- makes doing business harder
Uncertainty as value changes day to day
Lack of investment- because of the uncertainty
Speculation- fluctuation encourages hot money movement from country to country, so more fluctuation occurs

Question 9

Arguments for fixed exchange rate

Answer 9

Avoids currency fluctuation
Stability encourages investment
Keep inflation low

Question 10

Disadvantages of fixed exchange rate

Answer 10

Current account imbalances- over valued exchange rate could cause a currency account deficit
Less flexibility- difficult to respond to temporary shocks
Conflict with other objectives

Question 11

Managed floating

Answer 11

When the central bank may choose to intervene in the foreign exchange markets to affect the value of a currency to meet specific macroeconomic objectives

Question 12

To achieve lower exchange rates (managed floating)

Answer 12

Lower interest rates would cause less investment into banks ; less savings, reducing currency as more supplied
Buy more foreign currency
Taxation of overseas currency deposits & capital controls- cut profit from hot money flows (disincentive to invest)

Question 13

Why attempt depreciation

Answer 13

Improve the balance of trade in goods ; services/ improve current account position
Reduce risk of deflationary recession by making exports expensive (increase exports & price level)
Rebalance economy away from domestic consumption towards exports & investment
Reduce government debt by selling foreign currencies

Question 14

Why attempt appreciation

Answer 14

Curb demand pull inflationary pressures

Reduce price of imported capital ; technology

Question 15

revaluation

Answer 15

increase exchange rate under fixed exchange rate

Question 16

appreciation

Answer 16

increase in exchange rate under floating exchange rate

Question 17

devaluation

Answer 17

decrease the exchange rate under fixed

Question 18

depreciation

Answer 18

decrease the exchange rate under floating

Question 19

factors influencing floating exchange rate

Answer 19

relative interest rates- if high, more money into banks from elsewhere, increased demand for currency, appreciate
relative inflation rates- higher, purchasing power fall, value fall
current account balances- supply for currency increase with demand, currency depreciate
FDI- high FDI, increased demand, appreciate
speculation- greater levels, lower value

Question 20

competitive devaluation/ depreciation

Answer 20

a country engineer exchange rate with the aim of improving its net trade balance. if countries follow suit, ‘currency war’ may occur (devalue currency to stimulate economy)

Question 21

impact of changes in exchange rate: current account of the BofP

Answer 21

devalue/ depreciation- decrease in export price, increase in import price, so increased competitiveness, improve BofP. however, Marshall learner (only lead to improvement if price elasticities is greater than 1), and j curve (worsen before gets better). so only will be long run

Question 22

impact of changes in exchange rate: economic growth and employment

Answer 22

devalue/ depreciation- increase in AD as net exports rise, rise in output, so increased employment

Question 23

impact of changes in exchange rate: inflation

Answer 23

increase price of imports of raw materials, increase in cost of production-so cost push inflation. increase AD could also increase rate of inflation

Question 24

impact of changes in exchange rate: FDI flows

Answer 24

depreciate/ devalue- cheaper for countries with higher value to give money to