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A-level Economics- Theme 4 > Exchange Rates > Flashcards

Exchange Rates Flashcards

1
Q

Define nominal exchange rate

A

Number of units of domestic currency that can purchase 1 unit of foreign currency

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2
Q

Define real exchange rate

A

Nominal exchange rate adjusted to reflect the different inflation rates of 2 countries- shows competitiveness of currencies

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3
Q

Define effective exchange rate

A

Estimated to measure movements of country’s 💴 value (average change rate) in basket 🧺 of currencies 💴 of trade partner countries

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4
Q

Define trade weighted exchange rate

A

Common form of effective exchange rate- average exchange rate in basket 🧺 of currencies 💴 weighted by amount of trade with each country

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5
Q

Define exchange rate

A

Rate at which 1 currency 💴 exchanges for another

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6
Q

How many exchange rate systems are there?

A

3

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7
Q

What are the exchange rate systems?

A

1) Floating exchange rate
2) Fixed exchange rate
3) Managed exchange rate

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8
Q

Define floating exchange rate

A

Market forces (supply of 💴 and demand for 💴) determine value at which 💴 exchanges for another

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9
Q

Define fixed exchange rate

A

Value at which 1 💴 exchanges for another fixed by central bank or government against another 💴 OR 🧺 of currencies OR

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10
Q

Define managed exchange rate

A

Market forces (supply of and demand for 💴) determine value at which 1 💴 exchanges for another BUT intervention by central bank influences exchange rate of 💴

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11
Q

Define revaluation

A

ONLY occurs under system of fixed exchange rate when government decides to ⬆️ value of 💴 against other currencies 💴 OR gold

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12
Q

Define appreciation

A

Occurs under system of floating OR managed exchange rate when value of 💴 ⬆️ against another 💴 due to market forces

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13
Q

Define devaluation

A

ONLY occurs under system of fixed exchange rate when government decides to ⬇️ value of 💴 against other currencies 💴 OR gold

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14
Q

Define depreciation

A

Occurs under system of floating OR managed exchange rate when value of 💴 ⬇️ against another 💴 due to market forces

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15
Q

State the factors that influence the value of a country’s currency 💴 against other currencies 💴?

A

1) Relative inflation rates
2) Relative interest rates
3) State of economy
4) Balance of payments on current account
5) Political stability
6) Speculation

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16
Q

How do relative inflation rates influence the value of a country’s currency 💴 against other currencies 💴?

A

High inflation-> ⬇️ in currency value … if country’s inflation rate ⬆️er than major competitors then according to PPP (common currency … rate at which product sold at same price in 🇬🇧 and abroad) currency ⬇️ in value

17
Q

How do relative interest rates influence the value of a country’s currency 💴 against other currencies 💴?

A

⬆️ interest rates attract foreigners with surplus balances to place them in that countries 🏦 (🔥💵)- allows interest to be earned at favourable rate … demand for that country’s currency 💴 ⬆️-> ⬆️ value of 💴

18
Q

How does the state of the economy influence the value of a country’s currency 💴 against other currencies 💴?

A

If economy performing well-> ⬆️ confidence of speculators and foreign investors- buy 💴 … causing value to ⬆️

19
Q

How does the balance of payments on the current account influence the value of a country’s currency 💴 against other currencies 💴?

A

Persistent deficit-> ⬇️ demand for currency as foreign consumers ✖️ demanding your 🚘 and … ✖️ demanding your currency … causing 💴 to ⬇️
EVALUATION- factor ✖️ significant in practice because flows of 💵 associated with trade are small compared with 🔥💵 flows and other transactions recorded in financial account

20
Q

How does political stability influence the value of a country’s currency 💴 against other currencies 💴?

A

Instability (potentially in developing countries)-> loss of confidence in country’s 💴 by speculators and forget investors … -> ⬇️ demand for 💴 and … ⬇️ value

21
Q

How does speculation influence the value of a country’s currency 💴 against other currencies 💴?

A

Positive ➕ speculation-> ⬆️ demand for 💴 and … ⬆️ value

Negative ➖ speculation-> ⬇️ demand for 💴 and … ⬇️ value

22
Q

In how many ways can the exchange rate of a currency be influenced?

23
Q

How can the exchange rate of a currency be influenced?

A

1) Foreign currency transactions

2) Interest rates

24
Q

How can foreign currency transactions be used to influence the exchange rate of a countries currency?

A

To cause appreciation ⬆️:
Central 🏦 buys its own 💴 on foreign exchange market in EXCHANGE for foreign 💴-> ⬆️ demand for own 💴-> appreciation

To cause depreciation ⬇️:
Central 🏦 sells its own 💴 on foreign exchange market in EXCHANGE for foreign 💴-> ⬆️ supply of own 💴-> depreciation

KEY 🔑 TO REMEMBER- foreign EXCHANGE market … you either EXCHANGE your own 💴 for foreign 💴 OR you exchange foreign 💴 for your own 💴

25
How can interest rates be used to influence the exchange rate of a countries currency?
To cause appreciation ⬆️: Central 🏦 ⬆️ interest rates-> makes domestic currency ⬆️ attractive for foreign citizens to place 💵 in countries 🏦s ... ⬆️ demand-> appreciation To cause depreciation ⬇️: Central 🏦 ⬇️ interest rates-> makes domestic currency ⬇️ attractive for foreign citizens to place 💵 in countries 🏦s ... ⬆️ supply-> depreciation
26
What are competitive devaluations/depreciations?
ALSO known as currency 💴 war ⚔️: When deliberate devaluation/depreciation ⬇️ by 1 country to gain competitive advantage (exports cheaper)-> other countries taking measures to ALSO devalue/depreciate their 💴 to ALSO gain competitive advantage
27
What are the effects of competitive devaluations/depreciations (currency war)?
1) ⬆️ inflation as imports ⬆️ expensive ... cost push inflation 2) ⬇️ in world trade- due to uncertainties with fluctuating exchange rates 3) retaliation in the form of protectionist measures e.g. tariffs (happened in 1930s)
28
What is the effect of a change in the exchange rate of a currency on the current account of the balance of payments?
Depreciation/devaluation makes country’s goods and services ⬆️ competitive as exports cheaper ... -> ⬆️ in exports AND imports ⬆️ expensive ... -> ⬇️ in imports -> improvement in current account as size of deficit reduced
29
What is the Marshall Lerner condition?
Marshall Lerner condition- summ➕ of price elasticities of demand for imports and exports MUST be ⬆️ than 1 For there to be an improvement in the current account the Marshall Lerner condition MUST be fulfilled
30
What is the improvement on the current account following a fall in the exchange rate dependent on?
The Marshall Lerner condition
31
What is the J curve effect?
Time ⏰ lag before full effects of depreciation of 💴 work through economy ... sum of PEDs of imports and exports between 0 and 1 in short-run BUT ⬆️ than 1 in long-run
32
Explain the J curve effect and why it occurs
INITIALLY (short run) current account deteriorates because demand for imports is price inelastic (... demand remains fixed) due to contracts or stocks of 🚘 (AND because currency depreciates, imports are more expensive and ... value of goods imported ⬆️ ... outflow of 💵 ⬆️ relative to inflow of 💵 hence current account deterioration) ALSO demand for exports inelastic as takes time for consumers to adjust to price change In the LONG TERM- demand for imports and exports may become ⬆️ elastic AND if Marshall Lerner condition fulfilled-> improvement in current account
33
What is the effect of a change in the exchange rate of a currency on economic growth and employment/unemployment?
Appreciation-> ⬇️ exports and ⬆️ imports as exports expensive and imports cheaper-> ⬇️ in net exports/trade (X-M)-> ⬇️ AD-> leftward shift in AD-> ⬇️ real output ALSO this-> ⬇️ in employment and ⬆️ in unemployment Depreciation-> ⬆️ exports and ⬇️ imports as exports cheaper and imports more expensive-> ⬆️ in net exports/trade (X-M)-> ⬆️ AD-> rightward shift in AD-> ⬆️ real output ALSO this-> ⬆️ in employment and ⬇️ in unemployment
34
What is the effect of a change in the exchange rate of a currency on the rate of inflation?
1) Demand pull inflation- ⬇️ in exchange rate-> ⬆️ in AD as net exports ⬆️-> inflation (⬆️ AD = ⬆️ inflation- price of goods bid up) 2) Cost push inflation- ⬇️ exchange rate-> ⬆️ import prices-> leftward shift in AS curve due to ⬆️ production costs-> ⬆️ inflation
35
What is the effect of a change in the exchange rate of a currency on FDI flows?
Appreciation = ⬇️ attractive for foreign companies to invest as 1 unit of foreign 💴 buys ⬇️ units of domestic 💴 BUT if appreciation means 👍 future growth prospects and ➕speculation THEN FDI inflows may ⬆️ Depreciation = ⬆️ attractive for foreign companies to invest as 1 unit of foreign 💴 buys ⬆️ units of domestic 💴 BUT if depreciation indicates lack of confidence in country’s economy THEN FDI inflows may ✖️ ⬆️

A-level Economics- Theme 4 (14 decks)

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