Exchange Rates And Balance Of Trade Flashcards
What is meant by a free-floating exchange rate
- control by demand and supply in the forex market
- no intervention by central bank
- at equilibrium
What are the 3 main sources of demand for the USD
- Foreign firms/consumers that buy goods produced in the US
- Foreign firms that want to invest in US (FDI or portfolio investment)
- Forex traders on longs and hoping for USD to appreciate
What are the 3 min sources of the supply of USD
- US firms/consumers that buy goods produced by foreign countries
- Firms/households form US that want to incest abroad (FDI or portfolio investment)
- Short sellers on the forex market
What is meant by the free market equilibrium exchange rate (say for USD)
When quantity demanded of USD = quantity supplied of USD
What are the 2 broad factors that affect the exchange rate of a currency
- Change in demand for a currency
- Change in supply of a currency
What are the factors for a change in demand of a currency (3)
- Change in demand for US goods and services by foreigners
- Changes in the relative interest rate between countries - if interest rates are higher, financial assets are more attractive (bond yields, bank savings) are higher
- Changes in the expectation of forex traders about future value (economy, fiscal and monetary policy etc)
What are the factors influencing the change in supply of a currency (take USD) - 3
- Change in demand for foreign goods produced by foreign countries (more demand for imports, more supply of currency)
- Changes in interest rates
- Changes in expectations of forex traders
What is the relationship between a fall in interest rates in the US relative to Singapore and the USD
Fall in interest rates in US -> capital outflow to foreign countries -> depreciation of USD (due to increased supply in forex market)
What should be used to describe changes in the free-floating exchange rate system
market adjustment process
- increase in demand -> DD curve shifts -> shortage at original price (Qd exceeds Qs) -> upward pressure on price > new ram where shortage is eliminated
Say there is an increase in demand for Chinese exports. How does the fixed exchange rate system work here (in relation to USD)
- increased demand for exports — increased demand for currency -> currency would have a tendency to appreciate if left to free market (represented by DD shift to the right)
- central bank of china counteracts this buy buying USD using Yuan to increase supply by same magnitude of increase in demand
- original price maintained
How does a managed flat exchange rate system work
- in between fixed and free-floating — acceptable band in which the currency operates, before requiring government intervention
To counteract a depreciation in the Singapore dollar, what should the MAS do under the managed float exchange rate system
- sell foreign reserves for Singapore dollars to increase demand and shift DD right -> return back to original price
Positive consequence of exchange rate stability
- reduction in uncertainty -> improvement in capital and financial accounts through stable environment for foreign investment
3 shortfalls of a fixed exchange rate system
- difficult to maintain in LR due to foreign reserves accumulation limits
- Opp costs (foreign reserves usually invested into highly liquid assets but with low yield)
- inflationary if country tries to maintain exchange rate below free market exchange rate (selling domestic currency would cause depreciation and thus inflation)
Define BOT
Value of difference between export revenue and import expenditure over a given period of time
Which account is the BOT under
Current account
Do countries with a free floating exchange rate have a reserve assets account
No.
What are the 5 main causes of a balance of trade deficit or surplus
- Cyclical changes in global conditions
- Changes in international competitiveness
- Change in exchange rates
- Government policies
- Random factors/shocks
If a trading partner’s real national income rises, what determines the extent to which import expenditure increases
Marginal propensity to import
