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Economics (vicky) > Exchange Rates and Calculations > Flashcards

Exchange Rates and Calculations Flashcards

1
Q

Exchange rates

A

The value of one currency expressed in terms of another currency

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2
Q

Exchange Rate Index

A

An exchange rate index expresses one currency against a collection/basket of other currencies

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3
Q

Fixed/Pegged Exchange Rate System

A
  • Where the central bank intervenes in the market to ensure the exchange rate is exactly fixed to a predetermined value of currency

TERMINOLOGY USED:
Revaluation (increase in value)
Devaluation (decrease in value)

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4
Q

Floating/Flexible Exchange Rate Systems

A
  • Where the forces of demand and supply determine the price of the currency

TERMINOLOY USED:
Appreciation (increase in value)
Depreciation (decrease in value)

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5
Q

Managed Float Exchange Rate Systems

A
  • Where the currency is able to float within a narrow band of the other currency. It provides stability

TERMINOLOGY USED:
Appreciation (increase in value)
Depreciation (decrease in value)

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6
Q

Pros of High Exchange Rates

A
  • Downward pressure on inflation
  • More imports can be bought
  • Forces domestic producers to improve their efficiency because price is high, producer have to focus on quality to compensate for high price
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7
Q

Disadvantages of High Exchange Rates

A
  • Damage to export industries
  • Damage to domestic industries who cannot compete with cheaper foreign goods
  • Unemployment problems if it continues in the longer term
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8
Q

Pros of Low Exchange Rates

A
  • Greater employment in export industries
  • Greater employment in domestic industries
  • Improves employment
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9
Q

Cons of Low Exchange Rates

A
  • Inflation
  • Competitors may complain
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10
Q

Pros of Flexible Exchange Rates

A
  • Automatic adjustment using forces of demand and supply to return to a stable level
  • No large foreign exchange reserves required
  • Free to set monetary policy and interest rates for domestic issues
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11
Q

Cons of Flexible Exchange Rates

A

Uncertainty

  • Business planning
  • Investment
  • Speculation

No discipline required for interest rates
Affected by more than just supply and demanded

  • Government Intervention
  • World Events

May worsen inflation

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12
Q

Pros of Fixed Exchange Rates

A

Certainty and stability

  • Business planning
  • Investment

Provides discipline

  • Money supply
  • Interest rates

Solves inflationary problems
Reduces speculation in the forex market

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13
Q

Cons of Fixed Exchange Rates

A
  • No automatic adjustment
  • Requires large foreign exchange reserves
  • Monetary policy may be inappropriate
  • Imported inflation
  • Setting the level is complex
  • If it is too low (e.g. China) there is international disagreement
  • Problems with overvaluation and undervaluation
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14
Q

Factors that cause an increase in supply

A

Increase in Supply:

  • Increase in imports
  • Foreign country interest rate is high → Increase in domestic investment abroad
  • Decrease in foreign inflation rate
  • Speculators believe that domestic currency will fall (depreciation)
  • Domestic country sells domestic currency (increase in foreign reserves)
  • Rise in real income
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15
Q

Factors that cause a decrease in supply

A

Decrease in Supply:

  • Decrease in domestic imports
  • Foreign country interest rate is low → Decrease in domestic investment abroad
  • Increase in foreign inflation rate
  • Falling real income
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16
Q

Factors that cause an increase in demand

A

Increase in Demand:

  • Increase in domestic exports
  • Increase in foreign investment abroad
  • Domestic country interest rate is high
  • Decrease in domestic inflation rate (deflation)
  • Speculators believe that domestic currency will rise (appreciation)
  • Domestic country buys domestic currency (decrease in foreign reserves)
17
Q

Factors that cause a decrease in demand

A

Decrease in Demand:

  • Decrease in domestic goods/services exports
  • Decrease in foreign investment abroad
  • Domestic country interest rate is low
  • Increase in domestic inflation rate
18
Q

Explaining an exchange rate diagram

A
  1. State event/situation
  2. Whose behavior changes
  3. How/Why the behavior changes
  4. Identify which curve (supply or demand)
  5. Shift in curve
19
Q

Important: What effect whom?

A

There are 4 groups of people whose behaviour changes:

  • People inside the country (consumers, investors) - SUPPLY ↑↓
  • People outside the country (consumers, investors) - DEMAND ↑↓
  • Central bank/government - SUPPLY ↑ DEMAND↑ (Increases only)
  • Speculators - SUPPLY ↑ DEMAND↑ (Increases only)

Inflation and Interest rates impact both people inside and people outside. (DOUBLE SHIFT)

Interest rates impact INVESTORS not BORROWERS (we don’t borrow money across borders typically).

20
Q

Automatic Adjustment

A

Flexible exchange rate will automatically adjust to resolve a trade deficit

Economics (vicky) (16 decks)

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