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Economic A Level > Exchange Rates Year 2 > Flashcards

Exchange Rates Year 2 Flashcards

1
Q

What are the 4 types of exchange rate systems

A

Free Floating System
Managed Floating System
Semi-Fixed System
Fixed Rate System

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2
Q

What is a free floating system

A

It is when the value of a currency is determined by market forces in the Forex market
Sterling floating since Black Wednesday 1992

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3
Q

What causes the demand for the pound

A

Demand for visible and invisible exports
Demand to set up business in the UK (FDI)
Demand to buy shares in UK plc’s
Demand to save in UK banks
Speculation that the pound will appreciate

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4
Q

What causes the supply of the pound

A

Demand for foreign visible and invisible exports
Demand to set up UK businesses overseas
Demand to buy shares in foreign plc’s
Demand to save in foreign banks
Speculation that the pound will fall

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5
Q

What is a managed floating exchange rate

A

The value of the currency is largely determined by market forces but there is some intervention by the central bank to change the exchange rate

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6
Q

How does the central bank effect the exchange rate

A

Buying and selling its currency
Altering the rate of interest

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7
Q

How would a central bank depreciate its currency

A

Sell its currency
Cut the base rate of interest

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8
Q

How would a central bank appreciate its currency

A

Buy its currency
Raise the interest rate

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9
Q

What is hot money

A

It is an expression for large sums of footloose, mobile international wealth that is moved at very short notice
Currencies are an asset option and the interest rate is the rate of return

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10
Q

What is a semi-fixed exchange rate

A

A more formal version of a managed floating system
The currency is given a specific target rate and managed by the central bank
The target is changed by announcing a revaluation or devaluation

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11
Q

What is the Exchange rate Mechanism

A

Semi-fixed exchange rate system was used to create the euro
It stabilises the currencies before it removes them and replaces it with a single currency
Used for the sterling between 1990-92

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12
Q

What is a fixed exchange rate

A

Where the exchange rate is fully pegged against another variable
The central bank uses intervention to keep the exchange rate pegged
The pound was on the gold standard and dollar standard

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13
Q

What are the 2 main fixed exchange rates

A

The sterling system which an English, Welsh, Scottish and Northern Irish pound are all fixed at a 1:1
The Eurozone which all share the euro

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14
Q

What are the rules needed for multiple countries to use the same currency

A

Each nation must surrender its use of domestic monetary policy - 1 central bank
Each nation will have to coordinate its fiscal policy
Agreement that allow transfers of money between richer and poorer members of the monetary union

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15
Q

What are examples of fixed exchange rate regimes

A

The Gold Standard - pegged to the value of gold
Currency Unions - Sterling, Euro

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16
Q

What are the reasons for a free floating exchange rate

A

No need to hold currency reserves for intervention
Freedom to use domestic monetary policy to pursue other wider economic objectives
Automatic self correction of a trade imbalances

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17
Q

How does a country self correct its trade deficit with a floating exchange rate

A

A trade deficit means that more £’s are being sold by UK consumers for imports than being bought by foreign consumers for UK exports
This causes a surplus of £’s, which causes a currency depreciation
This change in value should make the demand of imports to fall and exports to rise
This shrinks the deficit

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18
Q

What conditions must be met for the self-correction to take place

A

The Marshall Lerner Rule

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19
Q

What is the Marshall Lerner rule

A

That a trade balance will be corrected by a currency re-adjustment so long as the combined price elasticity of demand for exports and imports is greater than 1

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20
Q

What does a more elastic price elasticity of demand mean when the exchange rate changes

A

The greater the response from demand and the greater the change in revenue earned

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21
Q

What factors affect the PED for exports and imports

A

The degree of competition
Number of substitutes
Type of good - Luxury or Necessity

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22
Q

What is the evaluation of the Marshall Lerner rule

A

It is more likely to be met in the long run due to the J curve effect

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23
Q

What is the J curve effect

A

It is the effect of which consumers don’t switch their spending habits to cheaper products because of information failure or inertia or contracts with suppliers
This causes a time lag in the improvement of the trade balance

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24
Q

What does the J curve look like

A

The Deficit or surplus gets worse in the short run and then improves in the long run

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25
Q

What are the 2 types of J curve effect

A

The J curve effect - Deficits
The reverse J curve effect - Surpluses

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26
Q

What are the reasons for persistent trade equilibria

A

Exchange rates aren’t free floating
Financial flows on capital account are over-riding the flows of money on current account
Trade on goods and services is price inelastic and the Marshall Lerner rule isn’t met

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27
Q

What are the reasons for a fixed exchange rate system

A

The Trade and investment benefits
The reductions in the cost of currency hedging
Disciplines on domestic producers

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28
Q

What are the trade and investment benefits of a fixed exchange rate

A

The reduced currency risk
Firms have to monitor the change in price of goods but also the exchange rate
Investors may have their profits removed by a bad exchange rate
Consumers and investors can be confident of the future value of their spending and receipt

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29
Q

What is currency hedging

A

When businesses trade on forward markets at their own risk, which also costs them a percentage of the money

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30
Q

What does a fixed exchange rate do about the disciplines of domestic producers

A

It forces domestic producers to keep control of their production costs
They can’t rely on a currency depreciation to keep their competitiveness

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31
Q

What is the balance of payments

A

It is a record of all cross-border flows of money for the purposes of buying goods and services, primary and secondary income flows and all other movements of financial capital

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32
Q

What are the 2 principal sections of the balance of payments

A

The current account and the financial account

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33
Q

What makes up the current account

A

Visible and invisible trade
Primary Investment Income
Secondary Transfer Income

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34
Q

What is Visible trade

A

Goods
e.g. oil, textiles, food

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35
Q

What is invisible trade

A

Services
(financial, Tourism, shipping, sports)

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36
Q

What is visible and invisible trade equal to

A

The Balance of Trades

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37
Q

What is Primary Investment Income

A

‘DRIP’
It is income earnt by UK citizens from their assets overseas in the form of dividends, rent, interest and Profit

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38
Q

What is secondary Transfer Income

A

It is the transfer of money from UK citizens or the government to people or governments in foreign countries
In the form of aid or money for workers families

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39
Q

What is GNP and what is it made up of

A

Gross National Product
GDP + DRIP = GNP

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40
Q

Why does the UK have a trade deficit

A

Because our visible deficit > invisible surplus

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41
Q

What makes up the financial account

A

Investment and other capital flows:
Direct Investment
Portfolio Investment
Hot Money

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42
Q

What is direct investment

A

F.D.I
Foreign Direct Investment

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43
Q

What is portfolio investment

A

Investment in foreign assets
e.g. Bonds/Shares

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44
Q

What is hot money

A

Bank deposits from foreign savers trying to maximise their interest rate

45
Q

What does the Balance of Payments always sum to

A

0

46
Q

What is the 3rd account on the balance of payments

A

The capital account
Measures the small and insignificant value of non-monetary assets that cross borders following labour migration

47
Q

What does a deficit on the current account mean and what happens to the financial account

A

A deficit is when we consume more than the value of our GDP
This has to be financed by borrowing from overseas which causes a net inflow of funds resulting in a positive financial account

48
Q

What does a surplus on the current account mean and what happens to the financial account

A

A surplus is when we consume less than the value of our GDP
This allows us to lend money overseas which is a net outflow of money resulting in a negative financial account

49
Q

What happens if the balance of payments is not equal to 0

A

The exchange rate changes

50
Q

What happens to the exchange rate when the balance of payments is negative

A

Pound depreciates

51
Q

What happens to the exchange rate when the balance of payments is positive

A

Pound appreciates

52
Q

How does the UK run a financial account surplus

A

Positive :
F.D.I
Portfolio
Hot money

53
Q

How does the UK get F.D.I

A

Rich consumers
Stable democracy/law/economy
Skilled Labour
Low tax/regulations

54
Q

How does the UK get portfolio investment

A

Bonds are safe, AAA
Shares of companies are safe and established

55
Q

How does the UK get Hot Money in

A

Relatively high rate of interest
Safe Banks

56
Q

What are the consequences of a current account deficit

A

Net leakage = Reduced AD
Deflationary
Consume more than we produced so boost in short run living standards
Requires an inflow of currency on the financial account or currency depreciation

57
Q

What are the consequences of a current account surplus

A

Net injection = Increased AD
Inflationary
Consume less than we produced so reduction in short run living standards
Surplus of funds will be lent to other nations so outflow of currency on the financial account or currency appreciation

58
Q

What are the types of current account imbalances

A

Cyclical or structural

59
Q

What are cyclical current account imbalances

A

They are caused by swings in economic activity as the economy moves through the different phases of the trade cycle

60
Q

What is the current balance likely to be during the up swings of the trade cycle

A

The current account is likely to deterioate as more imports are sucked in
The more income elastic the demand for imports is, the greater the effect

61
Q

What is the current account balance likely to be during the down swings of the trade cycle

A

Current account improves because if the decreased amount of imports

62
Q

What is assumed when predicting the state of the current account through the trade cycle

A

Imports are normal goods
GDP level has no impact on the amount of UK goods we sell abroad

63
Q

What does an enduring imbalance in the current account suggest

A

If it isn’t explained by the business cycle the it will be due to structural imbalances

64
Q

What do current account imbalances reflect

A

Differences in the competitiveness of trading nations

65
Q

What is international competitiveness

A

The ability of domestic firms to win international market share on the basis of price and non-price supremacy

66
Q

What does a countries ability to compete internationally depend on

A

Relative prices of exports and imports (the terms of trade)
Relative inflation rates ( rate of divergence between exports and import prices)
Relatives production costs per unit
Relative productivity rates
The exchange rate
Relative quality and other non-price factors

67
Q

What does a country with the greatest competitiveness have when comparing inflation rate and price level

A

In the short run, it is the one with the lowest price level
In the long run you must consider the inflation rate for the future price level

68
Q

Whats the difference between price level and inflation

A

Price level is the average price of goods and inflation rate is the rate of change of the price level

69
Q

What is the terms of trade

A

The terms of trade measure the ratio of a country’s export prices to its import prices

70
Q

What is the equation for the terms of trade

A

Index of average export prices/Index of average import prices x 100

71
Q

What happens to the terms of trade if exports are rising faster than import prices

A

The terms of trade index is said to have improved
Fewer exports have to be given up in exchange for a given volume of imports

72
Q

What happens to the terms if trade if import prices rise faster than export prices

A

The terms of trade are said to have deteriorated
A greater volume of exports has to be sold to finance a given amount of imported goods and services

73
Q

What are the key determinants of the terms of trade

A

Relative productivity and unit costs
Relative inflation rates
Exchange rates

74
Q

What is the evaluation of the terms of trade

A

Rising terms of trade is usually seen as good
If it is due to a rise in demand for exports it is good
If it is due to inflation and a increase in costs then it isn’t good

75
Q

What are the evaluation points for relative inflation rates

A

It is only the rate of price increase of the subset of goods and services that effects the current account performance
It is the relative inflation rate against key trading partners
Demand pull inflation is less concerning than cost push

76
Q

What are the evaluation for productivity rates

A

It is the relative productivity and the gap between our trading partners
There is a focus on labour productivity when capital productivity is increasingly important

77
Q

What is the evaluation for exchange rates

A

Countries are tempted to use the exchange rate but is a form of protectionism that hides the structural inefficiency
Only works in the short run

78
Q

What is the evaluation for comparative advantage

A

Countries comparative advantages change over time and leave a mark on the current account

79
Q

What are the policies to cure or reduce a current account deficit

A

Policies that switch expenditure
Policies that reduce expenditure

80
Q

What are the policies that switch expenditure

A

Depreciation/Devaluation of currency
Protectionism

81
Q

What is the policy that reduces expenditure

A

Deflation

82
Q

What is a devaluation

A

The deliberate attempt by a country’s central bank to manipulate the value of the currency downwards

83
Q

What does a depreciation/devaluation of the currency do for a current account deficit

A

Switch consumer spending away from imports and to exports

84
Q

What are evaluation points of protectionism

A

Not allowed in economic unions
Don’t address the cause of lack of competitiveness
Provoke retaliation
Distorts comparative advantage and discourages specialisation

85
Q

What does deflation do for the current account deficit

A

Reduce income, so less imports
Fall in price level
Reduce real GDP
Normally done when the economy has a positive output gap

86
Q

What are the benefits of supply side policies

A

Likely to yield long run success because they target underlying causes of weak competitiveness

87
Q

What do supply side policies do

A

They aim to improve efficiency which product and labour markets operate in
Leading to rightward shift in the LRAS curve

88
Q

What is globalisation

A

It is a process through which national economies become increasingly integrated and interdependant

89
Q

What does the fact that globalisation is a process mean

A

That it is on-going
There have been waves of globalisation over the centuries temporarily impeded by protectionism and world wars

90
Q

What are the characteristics of globalisation

A

Free trade
Free movement of labour, capital, enterprise and technology

91
Q

How can the extent of globalisation be measured

A

The increase in the volume and value of world trade
It can also be measured individually as the size of X+M as a % of GDP

92
Q

What do cross border capital flows mean

A

Financial flows
FDI

93
Q

What are financial flows

A

Hot money flows

94
Q

What is FDI

A

Foreign Direct Investment
Expenditure on real physical capital in setting up or expansion of operations and production facilities overseas

95
Q

What is Offshoring

A

When work is outsourced to businesses in another country on the basis of lower unit costs (particularity unit labour costs)

96
Q

What are examples of globalisation

A

mass economic migration of labour
Nissan in Sunderland
UK retail banks with call centres in India
International supply chains

97
Q

What is driving greater globalisation

A

Multilateral trade agreements - reduce tariff barriers
Technological Advances - e.g internet
Collapse of Communism
Export led development strategies
Removal of capital controls
Relaxation of visa controls

98
Q

What are the pro-globalisation arguments

A

Increases global allocative efficiency
Countries can consume more than they produce
Developing countries living standards will rise
Help distribute income around the world
Helps investment in developing countries through FDI
FDI can accelerate the transition from a developing to a developed country
FDI countries normally pay a high relative wage
Increased competition will lower prices and give a greater choice
Trade will help developing countries increase living standards and less reliant on aid

99
Q

What are the anti-globalisation arguements

A

It doesn’t improve economic development for all citizens
The benefit of trade is unequal between developing and developed countries, making them relatively poorer
Trade leads to greater inequality
Large firms can have more power over the government
Leads to a loss of cultural diversity
Large firms exploit workers by not paying them their fair share
Firms cause large amounts of environmental damage

100
Q

What policies could be used by a developing country to develop further to an advanced country

A

Increased Globalisation
Supply-side policies

101
Q

What is the natural rate of unemployment

A

The equilibrium rate of unemployment
The rate where real wages have found their free market level and supply of labour is equal to demand for labour

102
Q

What does it mean for workers if the country is at its natural rate of unemployment

A

All workers who are willing and able to work at the wage rate found employment
No involuntary unemployment

103
Q

What unemployment still exits at the natural rate of unemployment

A

Voluntary or frictional unemployment
Structural unemployment

104
Q

What is voluntary or frictional unemployment

A

People who are looking for work with better wages or conditions
Workers between jobs
People leave for personal reasons like illness or retirement

105
Q

What is structural unemployment

A

As the economy evolves, there is a mismatch between workers’ job skills and employers needs
Happens when what, where or how goods are being produced

106
Q

What are the assumptions with the natural rate concept

A

Markets have the power to clear at an equilibrium an the labour market is like any other market

107
Q

What are classical economists view of cyclical unemployment

A

Cyclical unemployment occurs in the short run, but is removed by lower wages in the long run

108
Q

How does the government reduce the natural rate of unemployment

A

Focus on improving the efficiency of the labour market by removing what are called ‘labour market imperfections’

109
Q

What policies can the government do to reduce the natural rate of unemployment

A

Reform welfare benefits to reduce the unemployment trap where people remain unemployed by choice rather than work
Reforming trade unions to reduce collective bargaining and reduce labour immobility
Reduce income tax to improve incentive to accept work
More relaxed approach to labour migration
Make labour markets more competitive and flexible
No demand side policies

Economic A Level (22 decks)

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