Exchange Rates and Balance of Payments

Question 1

Exchange Rate

Answer 1

The value of a currency in terms of another

Question 2

Factors causing a fall in demand for a currency

Answer 2

• Decrease in tourism (less exports)
• Fall in the base rate (decrease flow of hot money, less return from saving)
• Increase in tariffs

Question 3

Factors causing a rise in demand (AFFECTS EXPORTS)

Answer 3

• Increase in tourism
• Increase in the base rate
• Decrease in tariffis

Question 4

Factors causing a fall in supply of a currency?

Answer 4

• Decrease in imports
• Inflation in the Eurozone
• Interest rates in other countries decrease

Question 5

Factors causing a rise in supply of currency?

Answer 5

• Increase in imports
• Deflation in the Eurozone
• Interest rates in other countries increase

Question 6

Analysis of Weak Pound

Answer 6

• Imports more expensive, exports cheaper
• increase in net exports
• assuming demand for imports and exports are price elastic
• AD will rise
• Real gdp will rise
• price level will rise

Question 7

Analysis of weak pound supply

Answer 7

• import prices rise
• cost of production for firms increases
• reduces AS
• inflation
• deter expansion by manufacturers (constraining growth and job growth)

Question 8

Evaluating the weak pound (J curve)

Answer 8

• current account may initially worsen
• firms stuck in contracts
• ped is inelastic
• decrease export revenues and increase importers revenues
• j curve

Question 9

Evaluating the weak pound (financial account)

Answer 9

• the financial account may see change short term but have medium term impacts on the current account
• foreign investors investing in the UK causes an inflow into the UK capital account
• however earns more for their current account long term in IPDs (investment income)

Question 10

Fixed exchange rate

Answer 10

policy makers intervene to keep a fixed value of the currency versus nominated other currencies

Question 11

Floating exchange rate

Answer 11

Where exchange rates are fully determined by market forces of supply and demand

Question 12

How does the central bank fix the exchange rate

Answer 12

• buy and sell a currency to keep the value at the correct value
• restrict capital flows
• charge interest rates

Question 13

Methods to control the demand for a currency

Answer 13

• control interest rates (higher interest rates to increase demand)
• BoE can sell dollars and buy pounds (increase in demand for pounds, appreciation

Question 14

Methods to control the supply for a currency?

Answer 14

• control tariffs (higher tariffs to reduce supply)

- Bank of England can sell pounds and buy FX- increase in the supply of the pound = depreciation

Question 15

Balance of payment

Answer 15

a record of all the movements of money in and out of a country over a period of time

Question 16

What is the balance of payments made up of

Answer 16

current account
financial account
capital account

Question 17

foreign direct investment

Answer 17

• foreign companies setting up in the UK = export

- UK companies setting up abroad = import

Question 18

portfolio investment

Answer 18

• foreigners buying UK bonds and shares or depositing money in UK banks (export)
• UK purchasing foreign bond and shares = imports

Question 19

Causes of current account surpluses

Answer 19

• weak exchange rate
• international competitveness
• high productivity
• economic growth and savings

Question 20

Causes of current account deficit

Answer 20

• a strong exchange rate
• lack of international competitiveness
• low productivity = higher costs of production therefore lack of price and cost competitiveness

Question 21

Determinants of the exchange rate: interest rate movements

Answer 21

• if UK interest rates increase relative to other economies, inflow of ‘hot money’
• increase demand for the pound
  -rise in the value of a currency
  higher exchange rate

Question 22

Advantages of floating exchange rates

Answer 22

1) monetary sovereignty = interest rates set on the needs of the Uk economy alone (manage inflation and unemployment) rather than having to change them to stabilise the exchange rate
2) automatic adjustment to the current account balance = a large current account deficit generates an outflow of pounds = exchange rate falling thus atomatically leading to restoring export competitveness

Question 23

Disadvantages of floating excahgne rate

Answer 23

1) uncertainty for businesses- not knowing future value of the currency makes it harder to plan input costs, selling prices
2)Overvalued = difficult for those wishing to export
Undervalued = generates cost push inflation

Question 24

Advantages of fixed exchange rate

Answer 24

1) easier trading for businesses, likely there will be an expansion of trade between those with fixed rates against another
2) monetary discipline = less likely to be cut in interest rates, which might be inflationary. keeps interest rates in line with the other economy

Question 25

Arguments for joining currency union

Answer 25

1) greater certainty for businesses that trade with members of the currency union
2) no costs involved in converting currency
3) greater price transparency for consumers

Question 26

Arguments against joining currency unioun

Answer 26

1) individual currencies lose the right to set their own monetary policy
2) Businesses may be unable to compete with lower cost producers that are members of the union and can’t benefit from a falling exchange rate

Question 27

Policies to increase trade surplus

Answer 27

1) Lower exchange rate
2) Policies to raise productivity
3) Investment in education and healthcare

Question 28

Lower Exchange Rate

Answer 28

improve competitiveness
reduce overseas price of exports
imports more expensive

Question 29

Policies to raise productivity

Answer 29

• methods to increase innovation and incentives to increase investment in industries with export potential
• compete more effectively with imports

Question 30

Investment in education and healthcare

Answer 30

• boost human capital

- increase competitiveness in fast growing and high value industries