exchange rates and the trilemma

Question 1

What are capital outflows? What do they affect?

Answer 1

Capital outflows increase the supply in the market for local currency; –> depreciating the local currency i.e. Brexit in UK

Question 2

What are capital inflows? What do they affect?

Answer 2

Inflows increase the demand for the local currency–> appreciating the local currency; i.e. when you think economy is doing well

Question 3

How do trade flows impact the ER/Currency?

Answer 3

Imports: increase the supply of the local currency–> depreciating the fund

Exports: increase the demand for the local currency–> appreciating the local currency

Question 4

Name Governmental interventios

Answer 4

indirectly through policies:
-> contractionary policy because of a high level of inflation: reduction in money supply leads to increasing interest rate, making it more attractive of capital inflow to (UK) increases demand in pound; tend to appreciate

-> directly by selling or buying local currency as central bank: increasing or decreasing foreign reserves at the same time

Question 5

Why UK bank did not intervene?

Answer 5

by intervening and buying pound to keep the ER stable, it would indirectly introduce a contractionary policy, by decreasing money supply, leading to higher r and a Recession

Question 6

What is the Exchange Rate Trilemma?

Answer 6

That countries apperently have to choose between three options:
1. Independent Monetary Policy (allow the govt. to react to economic shocks)

2. Stable Exchange Rate (reduces aúncertainity and facilitates investments and trades)
3. Free Capital Flows (to attract foreign capital)

It is impossible to have all free at the same time