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Economics > Global – Exchange Rates > Flashcards

Global – Exchange Rates Flashcards

1
Q

How do Supply and Demand affect the Foreign Exchange Market?

A

The demand for foreign currency generates supply of domestic currency, whereas the supply of foreign currency generates demand of domestic currency.

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2
Q

Define Exchange Rates

A

The value of one currency expressed in terms of another.

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3
Q

What are the Types of Exchange Rates?

A

1) Floating
2) Managed
3) Fixed

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4
Q

What Characterises a Floating Exchange Rate System?

A

Exchange rates are determined by market forces with no government or bank intervention.

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5
Q

Distinguish between Appreciation and Depreciation

A

Appreciation occurs when the value of a currency increases. Depreciation occurs when the value of a currency decreases. Both occur as a result of changes in demand and supply of a currency.

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6
Q

What are the Determinants of Currency Demand?

A
  • Exports: foreign demand, inflation, growth rates
  • Investment: FDI, portfolio inv., interest rates
  • Inward flow of remittances
  • Speculation of appreciation
  • Central bank intervention
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7
Q

What are the Determinants of Currency Supply?

A
  • Imports: domestic demand, inflation, growth rates
  • Investment: FDI, portfolio inv., interest rates
  • Outward flow of remittances
  • Speculation of depreciation
  • Central bank intervention
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8
Q

What happens when Both Currency Supply and Demand Change Simoultaneously?

A
  • Low rate of inflation: exports increase (currency app.)

* Low interest rates: investment increase (currency app.)

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9
Q

What are the Effects of Appreciation and Depreciation on Net Exports?

A

Appreciation: decrease in net exports (expensive)
Depreciation: increase in net exports (cheaper)

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10
Q

How can Exchange Rates affect the Rate of Inflation?

A

Change in net exports causes demand-pull inflation, whereas changes in imports causes cost-push inflation due to firm dependency on imported resources.

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11
Q

How can Exchange Rates affect Economic Growth?

A

Increase in net exports shifts AD to the right increasing potential output and creating short-term growth. Furthermore, increases in export industry can lead to investments in factors of production causing long-term growth.

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12
Q

How can Exchange Rates affect Unemployment?

A

Increases in AD caused by depreciation will curb cyclical unemployment in a recession, also, if the economy is close to potential output it could cause a temporary decrease in natural unemployment. This being said in the case of inflationary gaps, unemployment will be higher.

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13
Q

How can Exchange Rates affect Account Balance?

A

If imports > exports, the country will find itself in trade deficit. If imports < exports, the country will find itself in trade surplus.

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14
Q

How can Exchange Rates affect Foreign Debt?

A

Depreciation will increase foreign debt whilst appreciation will decrease foreign debt.

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15
Q

How can Exchange Rates affect Living Standards?

A

In relation to imports, depreciation makes the country worse off, whereas appreciation makes the country better off. Currency appreciation is likely to increase living standards.

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16
Q

What are the Characteristics of a Fixed Exchange Rate System?

A

This system will have fixed exchange rates controlled by the central bank at a particular level. Due to this, they are not allowed to change freely in response to changes in currency supply and demand. It hence requires constant intervention.

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17
Q

How can Central Banks Maintain Fixed Exchange Rates?

A 
Through the use of:
• Official reserves to buy currency
• Manipulating interest rates
• Borrowing from abroad
• Limit imports
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18
Q

What is Devaluation?

A

Refers to a decrease in the value of a currency in the context of a fixed or pegged exchange rate system.

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19
Q

What is Revaluation?

A

Refers to an increase in the value of a currency in the context of a fixed or pegged exchange rate system.

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20
Q

What are the Characteristics of a Managed Exchange Rate System?

A

Combines elements of both floating and fixed exchange rate: it is able to float however is subject to periodical intervention by central banks (this to prevent large fluctuations).

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21
Q

What are Pegging Exchange Rates?

A

Intervening on an exchange rate so that it floats between a range of values above and below a target exchange rate relative to another currency (usually dollar or euro).

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22
Q

Describe Overvalued Currencies

A

Overvaluation occurs when currencies have a value that is too high relative to its equilibrium in the free market. It can occur in fixed or managed systems. The consequences include:
• Imports are cheaper and exports are more expensive
• Worsen account balance (exports < imports)
• Hurt domestic producers

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23
Q

Describe Undervalued Currencies

A

Undervaluation occurs when currencies have a value that is too low relative to its equilibrium in the free market. It can occur in fixed or managed systems. The consequences include:
• Imports are more expensive and exports cheaper
• Unfair competitive advantage (dirty float)
• Can lead to cost-push inflation

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24
Q

What is the Balance of Payments?

A

The record of all transactions between the residents of a country and the residents of all other countries.

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25
Q

Distinguish between Debits and Credits

A

In the balance of payments credits represent inflows of money inside the country, whereas debits represent outflows of money from the country.
• Credits: creates foreign demand for country’s currency
• Debits: creates supply of the domestic currency

26
Q

What Accounts does the Balance of Payments consist of?

A

1) Current
2) Capital
3) Financial

27
Q

Explain an Account Surplus inside the Balance of Payments

A

A surplus in an account occurs whenever a balance has a positive value therefore credits > debits. A surplus of an account indicates there is an excess demand of the currency in the foreign exchange market.

28
Q

Explain an Account Deficit inside the Balance of Payments

A

A deficit in an account occurs whenever a balance has a negative value therefore debits > credits. A deficit of an account indicates there is an excess supply of the currency in the foreign exchange market.

29
Q

What must Accounts achieve in the Balance of Payments?

A

In the course of the year, all inflows of payments must be exactly equal the outflows of payments (credits = debits). The sum of all credits must hence equal to zero.

30
Q

What are the Components of the Current Account?

A
  • Balance of trade in goods (X – M)
  • Balance of trade in services
  • Income (out/inflows such as rent, interest, profits)
  • Current transfers (gifts, remittances, aid, pensions)
31
Q

What are the Causes of Deficit and Surplus inside the Current Account?

A

Deficit is usually due to an excess of imports over exports; surplus is usually due to an excess of exports over imports.

32
Q

What are the Components of the Capital Account?

A
  • Capital transfers

* Non-produced non-financial assets

33
Q

What are Capital Transfers?

A

Financial and non-financial assets including debt forgiveness, investment, non-life insurance claims.

34
Q

What are Non-Produced Non-Financial assets?

A

Non-produced assets such as land and intangible assets such as copyrights or patents.

35
Q

What are the Components of the Financial Account?

A
  • Foreign direct investment
  • Portfolio investment
  • Reserve assets
  • Official borrowing
  • Balance on financial account
36
Q

Explain Current Account Deficit using the PPC

A

A current account deficit means a country consumes more than it produces (exports > imports) therefore it is consuming at a point outside of the PPC curve.

37
Q

Explain Current Account Surplus using the PPC

A

A current account surplus means a country consumes less than it produces (imports > exports) therefore it is consuming at a point inside of the PPC curve.

38
Q

What is the Relationship between Current and Financial Account?

A

If there is a current account deficit there must be a financial account surplus because it provides foreign exchange needed for imports. Instead, if there is a current account surplus there must be a financial account deficit as the country is accumulating foreign exchange that can be used for foreign investment.

39
Q

What is the Relationship between Floating Exchange Rates and the Current Account?

A

When there is a current account surplus the currency experiences appreciation (hence exports decrease). When there is a current account deficit the currency experiences depreciation (hence exports increase).

40
Q

What is the Relationship between Fixed Exchange Rates and the Current Account?

A

The balance of payment is made to balance by policies (through banks) that change currency demand or supply in order to keep the exchange rate fixed.

41
Q

What is the Relationship between the Exchange Rate and the Financial Account?

A

If a country’s central bank is exerting contractionary monetary policy, this will attract higher FDI therefore increasing FInancial Account credits, this causes appreciation. The opposite causes depreciation.

42
Q

What is the Effect of Exchange Rate Systems on Stakeholder Certainty?

A
  • Floating: low certainty

* Fixed: high certainty

43
Q

What is the Effect of Exchange Rate Systems on Foreign Currency Reserves?

A
  • Floating: no need to hold reserves

* Fixed: requires sufficient reserves to maintain rate

44
Q

What is the Effect of Exchange Rate Systems on Correction of Current Account?

A
  • Floating: adjusts automatically

* Fixed: cannot be handled quickly/easily

45
Q

How can Deficits be Corrected in a Fixed Exchange Rate?

A 
Central banks can: 
• Use foreign currency reserves/foreign borrowing
• Contractionary policies
• Trade protection
• Exchange controls
46
Q

What is the Effect of Exchange Rate Systems on Inflation?

A

If rate inflation > trading partners:
• Floating: can be corrected through depreciation
• Fixed: fiscal policy (contractionary)

47
Q

What is the Effect of Exchange Rate Systems on Flexibility offered to Policy-makers?

A
  • Floating: high flexibility (no need of policies)

* Fixed: no flexibility (need of policies - no domestic)

48
Q

What is the Effect of Exchange Rate Systems on Speculation?

A
  • Floating: destabilizing (can cause changes in rate)

* Fixed: limiting as rate is controlled

49
Q

What are the Consequences of facing a Persistent Current Account Deficit?

A
  • Depreciation of exchange rate
  • Need of higher interest rates for FDI (but recession)
  • Selling domestic assets to foreigners (loss of control)
  • Increasing levels of debt
  • Cost of paying interest on loans
  • Fewer imports of capital goods (scarce foreign exch.)
  • Poor international credits
  • Pursuit of contractionary policy
  • Lower economic growth (resources needed for loans)
  • Lower standards of living (low economic growth)
50
Q

What Policies can be Adopted to Correct Persistent Current Account Deficit?

A
  • Expenditure reducing policies (contractionary p.)
  • Expenditure switching policies
  • Supply-side policies to increase competitiveness
51
Q

What are Expenditure Switching Policies?

A

Policies that involve switching consumption away from imported goods and towards domestically produced goods. Methods include trade protection or depreciation of currency.

52
Q

What is the Marshall-Lerner Condition?

A

Condition that allows depreciation to lead to an improvement in a country’s balance of trade.

53
Q

What does the Marshall-Lerner Condition state?

A

If PEDm + PEDx > 1 then dep. will improve balance

If PEDm + PEDx < 1 then dep. will not affect balance

54
Q

What Relationship exists between PED and Trade Balance according to the Marshall-Lerner Condition?

A

The greater the PED of imports and exports, the greater the scope of improvement in the trade balance because the higher the PED the smaller the depreciation needed to obtain improvements.

55
Q

What is the J-Curve Effect?

A

When a country is experiencing depreciation of its currency the trade balance will firstly worsen, later, the trade deficit will begin to shrink and the trade balance will begin to improve (with marshall-lerner condition).

56
Q

Describe a J-Curve

A

Graph that plots the balance of trade:
• X-axis shows time of depreciation
• Y-axis shows trade balance

57
Q

How is a Trade Deficit portrayed in the J-Curve?

A

Values less than zero on the y-axis represent a trade deficit (negative values).

58
Q

How is a Trade Surplus portrayed in the J-Curve?

A

Values more than zero on the y-axis represent a trade surplus (positive values).

59
Q

When does X – M = 0?

A

When imports and exports are equal.

60
Q

What are the Consequences of facing a Persistent Current Account Surplus?

A
  • Low domestic consumption
  • Insufficient domestic investment
  • Appreciation of domestic currency
  • Inflation
  • Employment (MIXED: lower AD however lower costs)
  • Reduced export competitiveness
  • Trade partners reduce imports from surplus country

Economics (18 decks)

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