Lesson 6 - Exchange Rate Policy Flashcards
What is an exchange rate?
The value of one currency in terms of another
What is the ERI?
- the Exchange Rate Index
- average of the UK’s exchange rate against countries that we trade with
Impact of a strong currency on imports and exports
Cheaper imports (can buy more for less)
More expensive exports
How are interest rates and exchange rates linked?
High interest rates = hot money flows in = demand for £ rises = currency strengthens
What are the 4 exchange rate systems?
- free floating
- fixed
- adjustable peg
- dirty floating
What is a free floating exchange rate?
- marker forces determine the value of the currency
- value demands on demand and supply of the currency
What is a fixed exchange rate?
Currency is pegged to another currency
What is an adjustable peg exchange rate?
Range within which the exchange rate can fluctuate, and rate is adjusted if it goes above or below this range
What is dirty floating?
Government tries to manage a freely floating exchange rate
Advantages of the euro
- eliminates exchange rate uncertainty
- easy price competition (boosts competitiveness)
- reduces transaction costs
Disadvantages of the euro
- cant devalue currency to improve competitiveness
- cant respond to an economic crisis
What was the ERM
- Exchange rate mechanism
- UK tried to peg its currency to reduce uncertainty
- Black wednesday
What was black wednesday?
What did the debt crisis mean for countries with a fixed currency like greece?
They were unable to weaken their currency to gain competitiveness and grow economically, so real wages fell
