Exchange Rates Flashcards
Define exchange rates
An exchange rate is the value of one currency, compared to the value of another
Daily exchange markup is roughly 4 trillion USD
What are, floating, fixed and managed exchange rates and economic context for each one
Floating exchange rates - An exchange rate which is is susceptible to change due to market forces. Can be influenced by a number of factors and policies. E.g. U.K.s exchange rate, 2021 interest rates at 0.1% in an attempt to devalue currency to make exports more competitive.
Fixed Exchange rate - An exchange rate which is held at a fixed value with some slight lenience know as pegs either side of the value. E.g. Chinas exchange rate is pegged at 8.28 yuan to the American dollar.
Managed exchange rate - Usually a floating exchange rate which the government can step in and control if needed in times of economic crisis. E.g. New Zealand. In order for New Zealand to intervene, they need to have sufficient foreign currency reserves in order to influence the currency.
Distinction between revaluation and appreciation of a currency and revaluation of a currency and economic context
Revaluation is the deliberate increase in the value of a fixed currency to achieve macro economic objectives.
Appreciation is the rise in the value of one currency in terms of another in a floating exchange rate system. U.K Pound appreciated 1.9% against the dollar from 1 pound = $1.22 to 1 pound = $1.39 when Boris Johnson’s conservative majority was predicted.
Distinction between Devaluation and depreciation of a currency.
Devaluation is the intentional, official devaluing of a fixed currency to help in times of economic need
Depreciation is the fall in the value of of floating exchange rate due to market forces. E.g. Value of the pound against the dollar dropped from 1$ = 1 pound 50p to $1 = 1 pound 22p due to the Brexit vote
Factors which influence floating exchange rates and economic context
Economic shocks - Coronavirus pandemic in march cause major uncertainty and the value of the pound depreciated 5% in just a day against the dollar from 1 pound. = $1.17 to 1 pound = $1.12 the lowest rate in 30 years
Political factors - Brexit vote in 2016 resulted in the pound depreciating from 1 pound = $1.50 to 1 pound =$1.22
Interest rates - Lower interest rates mean a reduction in demand for currency due to less hot money and return flowing in. E.g. UK Interest rate after financial recession of 2009 dropped from 5.25% to 0.5%
Confidence - Demand for a floating currency will improve if there is a solid return on investing with little risk.
Government Policy - If the government plans to encourage economic growth and domestic consumption, then they will likely encourage the central bank to lower interest rates and adopt loose fiscal policy.
Growth and GDP - Higher amounts of economic growth will strengthen the exchange rate as it improves confidence in the economy
Inflation - Controlled rates of inflation mean that the exchange rate will be at a steady value reducing business costs and improving confidence
Explain government intervention in currency markets through foreign exchange rates
Buying currency reserves allows people to have more confidence in the country’s ability to pay back debt E.G china has currency reserves of over 3.3 trillion USD
Government can encourage central banks to adapt interest rates to help control the interest rate depending on the type of macro economic objectives they want to tackle. E.g. current account deficit, lower interest rates to stimulate domestic demand because foreign goods become more expensive, and makes exports more competitive because it is cheaper for other countries as the pound is weaker.
Government Fiscal policies - Can improve incentive to export by subsidising export led businesses and FDI E.g. until 2008, foreign-owned firms in China that exported over 70% of their production enjoyed a 50% reduction in the corporate income tax rate.
Putting tariffs and quotas on foreign imports to improve incentive to buy domestically.
Impact of changes in exchange rates on 5 economic factors
Current account deficit - Lower exchange rates mean that the incentive to import goods reduces and businesses are encouraged to export because there prices become more competitive, vice versa
Economic growth - An exchange rate appreciation causes a slower growth of real GDP because of a fall in net exports (reduced injection) and a rise in the demand for imports (an increased leakage in the circular flow). … Thus a higher exchange rate can have a negative multiplier effect on the economy. Vice versa
Employment - Higher exchange rate likely results in more unemployment due to export led businesses having increased costs, and demand for imports from foreign business increasing because you can buy more for your money, meaning that domestic business will struggle to compete.
Inflation - will increase if there is a lower exchange rate because of demand for domestic goods increasing and foreign imported inflation will increase due to higher costs.
FDI - If the exchange rate appreciates then there will be more hot money flowing in because there is a higher return on saving, thus increasing the demand for currency.
Businesses will see less incentive to work in the U.K with a higher exchange rate because costs will increase.
Evaluation points over a fall in exchange rates
Marshall learner condition - Applies especially in the U.K, goods such as factors of production increase in price due to the depreciation in the currency value, but need to be imported to produce anyway. Thus leading to imported inflation.
J-Cure - A depreciation in the exchange rate means that businesses will need time to adapt to the costs so they will still import the same amount of costs, thus further increasing inflation and unemployment. However then businesses will adapt and improve there exports, likely meaning that it gets worse before it gets better.
Draw the J curve
A graph with a horizontal line through the middle as the X axis, The X axis illustrates time.
Beneath the line is a trade deficit
Above the line is a trade surplus
Plot the deficit line and then illustrate a further drop when either depreciation or devaluation occurs, and then after a short period show a gradual increase as a result of the policies and the depreciation.
