Internat Trade- Exchange Rates

Question 1

Supply of currency

Answer 1

Demand for imports, demand oversees assets for investment pruposes-= hot money flows, fdi,=- by a countries citizens

Question 2

Demand of currency

Answer 2

Demand for countries exports and financial assets= fdi, portfolio
Increased interest rates would increase demand

Question 3

Equilibrium exchange rate

Answer 3

S=d
Amount of currency which exports and forign investors demand is qual to that which imports and home investors supply

Question 4

During periods econ growth exchange rate

Answer 4

When output increase, real incomes increase
Increased demand imports esp with high mpm
If uk citizens import more /supply of sterling on forign exchange markrets will increase

Question 5

Choice for exporters about prices when er falls

Answer 5

If demand elastic, decrease foriegn prices and sell more as depreciate

Question 6

Forward cover

Answer 6

Allow firms to avoid some er risk buy currency at a rate fixed in advance
Hedging

Question 7

Exchange rate index

Answer 7

Trade weighted index
Measure competitiveness
Effe tive exxchange rate when measured against multiple other cuntries

Question 8

Floating exchange rate adv

Answer 8

Automatic adjustment bop
Efficient allocation of resources
Freedom to persue macro econ objective
Independant monetary policy

Question 9

Floating exchnage rate adv- autmoatic adjustment bop

Answer 9

In theory providing demand for imports and exports is elastic- marshall lerner condition, deficit on current account
Depreciate currnecy
Xpotrs companies imports more expensive, decrease deficit
Country with currenct account surplus, increase value currency
Decrease demand exports, increase imports
Leave a gov free to persue domestic macreoecon obejctives without need to use fiscal policyu to deflate eocn and ammend deficitt

Question 10

Floating exchnage rate adv- efficient allocation of resources

Answer 10

In a country change world where there is a shift in comparative adv betwene countrues - structural econ change
Market prices should reflect change sd
Freely floating exchnage rates respond to these cnages facing a roe efficient allocation of resources

Question 11

Floating exchnage rate adv- freedom to persue macroecon objective

Answer 11

Provided a floating exchange rate leads to correction of bop gov free to use fiscal policy to persue domestic policu
No need to increase dfirect taxes to decrease demand to reduced feficit

Question 12

Floating exchnage rate adv- independent monetary policy

Answer 12

Central bank may not need to increase or change interest rates to maintain a fixed exchange rate e rate
No need for central bank to maintain large suprlus of foriegn currency reserves

Question 13

Disadv of floating exchnage rates

Answer 13

International trade uncertainty
Speculative capital flows
Depreciation lead to cost push inflation

Question 14

Disadv floatinge xchnge rate - internat trade uncertainty

Answer 14

Exporterd cannot be certain of teh price of their gs on foriegn markets- importers cannot be sure of cotst of imports
Make business planning diff which can stifle investment
But can use forward market in st to decreae uncertainty but v expensiove

Question 15

Disadv floatinge xchnge rate- speculative capitla flows

Answer 15

Hot money flows
Can lead to sharp rises and falls in excnage raets that do not necessarily reflect trading conditions- demand for importers and exports
Econ would argue fixed exchange rates may be speculative hot money flows= speculators believe currency overvalued erm 1992 crisis

Appreciation of currency due to hot money flows may make more diff to decrease deficit on currenct account- usa exports at present

Question 16

Disadv floatinge xchnge rate- history of hot money flows

Answer 16

Uk demand for sterling strong for specultaive invesment prupsoes, often dwarfs influence of trade
1990s- 2008 international trade high, strong demand for pound sterling investment
Yet uk huge bop deficit- should lead to depreciation- but interest rates high- didnt
Not benefit fron main adv fkoating exchange rates- automatic adjustment of bop deficit

Question 17

Disadv floatinge xchnge rate- depreciation lead cost push inflation

Answer 17

Cost of imports and may have limited efect in decreasing a bop defiict on current account if marhsall lerner conditions not apply

Question 18

Fixed exchnage rate adv

Answer 18

Decrease riskier flucuations- encourage more internat trade
Discipline eocn management- if er fixed. Gov have an incentive to avoid a rate of inflation higher than that of competitiors
Firms encouraged to becmoe more copm in real terms rather than rthan rely on low er to sell exports

Question 19

Disadv of fixed exchange rate

Answer 19

No automatic adjustment bop to restore ea trade deficit in current account or reduce suplus
Fixed exchnage rates require a period of exon stablity between trading countries
Overval of currency can lead to a misallocation of resources- may unfairly penalise efficient exporters due to fixed ppound, theory of comparative advantage do not apply
Fixed exchnage rate may be vulnerable to speculative hot money flows out of exn if believ overvalued erm 1992
Loss of control independant montary policu= may be required to change interest rates to maintain value of currency
Central bank will need to keep adequate foriegn currency reserves maintain fixed exchnage rate

Question 20

Maintain fixed exchange rate- increase

Answer 20

Er rise above fixed level
Sell pound resrerves and buy foriegn currency
Shift supply right, decrease price incresde quantity
Or low interest rates, eddecrease demand increase supply, currency deperciate

Question 21

Maintain fixed exchange rate== fall below fixed level

Answer 21

Sell foregn currency buy pound
Shift demand right, raise price p1 to p2
Otherwise increase inetrest rates. Increase demand currecy, hot money, decreas esupply, appreciate

Question 22

Why interest rates less used fixed exchnagr rate

Answer 22

Foriegn currency morme precisie
Interest rates change wider impact

Question 23

Types of managed exchnage rates

Answer 23

Rigidly fixed exchnage rates
Adjustable peg
Managed float or dirty floating

Question 24

Adjustable peg

Answer 24

Where a currency is allowed to fluctiate within paramators- cieling and floors= around a specified value or peg
However central bank retains the power to adjust the central peg ro vaue to reflect any significant change in econ circumstances
Adjusting central peg same as revaluation fixed exchnage rate

Question 25

Managed float or dirty floating

Answer 25

Exchang rate officially floating but central bank may interfere unofficially behind the scenes. Buying or selling current to manage float er avoid sharp changes in er Boe intervene on foriegn exchnage markets on a daily basis to iron out shart day to day fluctuations ofn er- little evidence any attempt interfere with ture market alue Us politicians frequently accused chinese of intevening behind secens in foriegn exchange markets to decrease vkaue fo chinese yuan to boost exports Switzzerland accused

Question 26

Why was euro created

Answer 26

Encourage international trade across eu Aim create economic monetary union across single amrket of eu Some eu members refused to join and others thought not econ developed to be admitteded When creaeted uk denmark and sweden refused to join

Question 27

Benefits of single currency-

Answer 27

Despite spain and greece soveiegn dept crisis- still remian in single currency Rmemoval of er uncertainty Rmeovsl of trading costs cof exhcanging currency Grester price transfer Greater opp trade Fdi Low stable inflation and stable interest rates across eurozone

Question 28

Benefits of single currency- removal of er uncertainty

Answer 28

Create greater certainty buinsesses trading across single currency area

Question 29

Benefits of single currency- removal of trading costs of exchange currency

Answer 29

Lower costs for business- reduce price imporve comp

Question 30

Benefits of single currency- greter price transparency

Answer 30

Increasing comp fostering allocaticve and porductive efficieny

Question 31

Benefits of single currency- greater opp trade

Answer 31

Greater integration- econ of scale- lower av costs

Question 32

Benefits of single currency- fdi

Answer 32

For firms wishing to set up in single currency area Countries such as ireland beneift sharp increase fdi when join as english speaking for americas

Question 33

Benefits of single currency- low stable inflation and low interest rates

Answer 33

Some extent achieved- not driven political considereations Recently deflation more of concern

Question 34

Disadv single currency

Answer 34

Loss indepndent monetary policy Restricted fiscal policu Structural problems Transistion costs

Question 35

Disadv single currency - loss independent monetry policy

Answer 35

Imposes one size fits all Prblem if members at diff stage econ cycle Ie first join ireland sharp increase demand inflation from american fdi Yet couldnt increase interest rates to decrease ad Ireland fiscal policu by increasing tax to decrease demand pull Ureadb also esp struggle as large financial sector- eurobonds Piigs- protugal ireland itlay greece and spain ot cut interest rates to boost ad in deep recession Eurozone dominated by ger which bounced back quickly from recession- strong exprots Ger needed dhigh interest rates prevailed over smaller countries- may damage those In uk need higher interest rates due to lagre housing market- on of reasons why uk not join If scot indepndt and renain sterling also not independtnt mp but more fiscal

Question 36

Disadv single currency- restricted fiscal policy

Answer 36

Ecb sets ammount gov borrow- as high gov borrw put increasing prssure on interest rets- constrains spending out of recession Euro soveriegn debt crisis- this prolem -piigs structural deficit (covered up to join euro), icnrease diff to finance as a result recent credit crunch Balied out bu stronger countries and qe yet strict restrictions plsced on gov spending, decrease gdp and unemployment

Question 37

Disadv single currency- structural problems

Answer 37

Structural econ change- pockets of recession in uk- scot sw. ne- decrease manufacturing and coal mining Se boomming with growth financial services setcor and high tech indistuyres Uk regions in diff pays less tax per head and recives large tax grants theorugh ewelfare state Since soveirgn debt crisis- european financial state facilities- suppied gov in dfif in eurozone- geer forced more support piigs Eu- 750bill euro in new generation eu- fund recovery from covid Funded by collective debt or eurobonds but largley indebted to ger and austria Much money spent on subsisides- renewable emergy and buisness profiist support sustainable development of factories manufactor bateries silocn cgips- like ira

Question 38

Transition costs- disadv single currency

Answer 38

Vending machines,c ash machines parking nmeters changed for new notes and cons Accounting procedures and comput er programmes adopted Some bank employees lose jobs because foriegn exhcnage pt cut in size

Question 39

Marshall lerner conditions

Answer 39

When the sum of eelasticity of demand for both exports and imports is greater than 1 a fall of exchange rate will venetally lead to an improve in current account

Question 40

J curve effect

Answer 40

In st a devaluation or depreciation of currecy lead to deterioriation of current account before starts to improve Already paid for imports and exports and cannot change Vol imports change minimal st as order splaces well in advance Depreciation increase price imports, demand st inelastic Currenct account worsen beforre demand imprts and exports adapt to new real prices as deficit diverterd When beneifts of decreasing exchange rates realised not last long- icnrease price comp produced by devaluation may be wiped out due to cost push = relative increase import prices

Question 41

Polices to decrease current account surplus

Answer 41

Remove direct control imports= tarrifs and quotas Remove more subtle barriers to trade- cmplex admin procedure, safety standard, nationalistic purchasing polices- may be moved to achieve polictically Reval of currency on fixed exchange rate or allwo appreictae- fficieny depends on marshall lerner consition Relfation of ad monetary or iscal position may lead to demand pull inflation

Question 42

Examokes current account surplus

Answer 42

Ger- linked lose current deficy of trading partners in single currency areas Japan and jorea accused of denying their citizens accessto many foregn gs through subtle range of trade barriers such as complex trade procedure nationalistic pruschasing policies on part of ratilers and manufacturers