Exchange rates

Question 1

What are the two main types of exchange rate system?

floating exchange rate and fixed change rate

Answer 1

• A fixed exchange rate system is where the government or its central bank sets the exchange rate
• A floating exchange rate is free to move with changing supply of , and demand for a currency .

Question 2

What is a hybrid exchange rate system ?

Answer 2

-It is a mixture of fixed and floating .
Examples
-Managed floating , the exchange rate is mainly left to market forces , but the government will occasionally intervene to influence the exchange rate. For example to reduce the impact of an economic shock on the value of its currency.
-Semi fixed ,

-Pegged

Question 3

NOTES TARGET RATE

Answer 3

-Fixed exchange rate systems and certain hybrid exchange rate systems have a target rate .

Question 4

How can the government or central bank maintain the exchange rate at the target rate ?

Answer 4

-By controlling interest rates and by buying and selling the currency ( using foreign currency reserves ) to keep supply of and the demand for , the currency stable .

Question 5

Nominal exchange rate and real exchange rate ?

Answer 5

• Nominal exchange rate , an adjusted comparison of the value of currencies
• Real exchange rate , the nominal rate which is adjusted to take price levels into account.

Question 6

Bilateral exchange rate and Effective exchange rate ?

Answer 6

• Bilateral exchange rate , the comparison of just two currencies
• Effective exchange rate , a country’s currency is compared to a basket of currencies ( usually its trading partners )

Question 7

NOTES/ Market forces of Government Intervention cause exchange rates to Fluctuate

Answer 7

-The devaluation of a fixed exchange rate occurs when the exchange rate is lowered formally by the government .
They can achieve this by selling the currency.
-The opposite of exchange rate devaluation is exchange rate revaluation.
-The depreciation of a floating exchange rate is when the exchange rate falls. This might occur naturally due to market forces , although government action ( e.g. lowering interest rates ) might affect is indirectly.
-The opposite of exchange rate depreciation is exchange rate appreciation
-Competitive devaluation can occur in fixed or hybrid exchange rate systems. This is when the governments deliberately devalue their own currencies to improve international competitiveness .
-Competitive depreciation can occur in floating or hybrid exchange rate systems , government intervention might directly reduce the value of the currency , improving the country’s international compettiveness.

Question 8

Advantages of floating exchange rates

Answer 8

• Under fixed exchange rate systems , central banks require foreign currency reserves so that they can intervene to maintain their exchange rate target, a floating exchange rate will reduce the need for currency reserves.
• A floating exchange can help to reduce a BOP current account deficit , a BOP deficit will lead to a fall in the value of the currency , so if demand for exports and imports is moderately price elastic , exports will increase and imports will decrease , reducing the BOP deficit .
• A floating exchange rate means that a government does not need to use monetary policy e.g. interest rates , to help to maintain the exchange rate , it can be used for other objectives.

Question 9

Advantages of fixed exchange rate system

Answer 9

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