Lesson notes 26/02/20

Question 1

What is a Free floating exchange rate?

Answer 1

Demand and supply

Question 2

What is a Managed floating system?

Answer 2

there’s no specific desired value, but now and then govt tries to influence demand and supply e.g. changes in interest rates

Question 3

What is a Fixed exchange rate?

Answer 3

One exchange rate is set between the currency and others e.g. £1 always equals $1.62.

Question 4

What is a Pegged?

Answer 4

a currency is linked to a’basket’ of other currencies usually the main trading partners, so if their value goes up, so does the currency in question.

Question 5

What is the currency union?

Answer 5

e.g. the Euro same currency

Question 6

What are 4 cases for floating exchange rate systems?

Answer 6

1) Less need for currency reserves for the use in intervention.
2) Provides partial ‘automatic correction for a trade deficit by changing the relative prices of exports and imports
3) Freedom for domestic monetary policy
4) Useful instrument of macro adjustment

Question 7

What does Less need for currency reserves for the use in intervention mean?

Answer 7

Fixed central banks need to have large levels of currency reserves, domestic and foreign in which could be very costly

Question 8

What does Provides partial ‘automatic correction for a trade deficit by changing the relative prices of exports and imports mean?

Answer 8

Large current account deficit could imply that the UK is importing more than exporting. This means there is more supply of the pound than demand. This is increase supply of pound, as you are buying foreign currency to buy imports — this leads to depreciation of the pound —- WPIDEC—- with more expensive imports that should reduce demand for imports, reducing expenditure of them — exports become cheaper— so demand for exports should increase.

Question 9

What does Freedom for domestic monetary policy mean?

Answer 9

some fixed exchange rate system will require manipulation of interest rates in order to keep exchange rate fixed to a certain currency, there is no need in allocating exchange rates; you can use monetary policy to solve

Question 10

What does Useful instrument of macro adjustment mean?

Answer 10

e.g. lower currency can stimulate AD e.g. Appreciation against the US dollar in 2007 was helpful when world oil prices (based in $s) wee very high.

Question 11

What is a case against Floating exchange rate system?

Answer 11

They can be volatile reducing incentive for foreign investors to invest in domestic countries, puts of FDI and trade.

Question 12

What are 4 benefits of a cheaper currency?

Answer 12

1) Helps to re balance te economy ( i.e shifts away from reliance on domestic consumption)
2) Currency depreciation acts as a partial automatic stabilizer for economy
3) Possible multiplier and accelerator effects
4) Increases in the value of investment income from overseas assets.

Question 13

What are 3 risks from a falling currency?

Answer 13

1) inflationary effects from higher import prices ( cost push) ( higher import prices for raw materials)
2) Weak currency may deter foreign investors ( may require higher bond yields-increases cost of servicing debt)
3) Low elasticity of demand may limit the impact of currency depreciation on the trade balance and export volumes.