LS8 - Exchange Rates

Question 1

What is the point of a weighted exchange rate?

Answer 1

• to show how a currency’s value is changing against a country’s trading partners

Question 2

What is a foreign exchange market split into?

Answer 2

• a spot market for transactions that happen now
• a forward market for transactions that will happen at an agreed time in the future

Question 3

What determines a floating exchange rate?

Answer 3

• the forces of supply and demand

Question 4

Factors increasing demand for a currency -> currency appreciation

Answer 4

• increase in relative interest rates
• speculators anticipate rise
• increase in FDI - e.g. company setting up in UK have to pay costs in pounds
• rise in incomes abroad - they may purchase from UK
• increase in international competitiveness of domestic exports

Question 5

Factors increasing supply of a currency -> depreciation (people swap the currency for another)

Answer 5

• fall in interests rate
• speculators anticipate fall
• firms moving away from UK
• increase in incomes domestically

Question 6

Currency appreciation SPICED

Answer 6

• stronger pound imports cheap exports dear

Question 7

Negatives of currency appreciation

Answer 7

• lower growth due to potential current account deficit as imports > exports
• higher unemployment in exporting & domestic industries

Question 8

Benefits of currency appreciation

Answer 8

• lower inflation (DP and CP)
• cheaper imports so a rise in living standards for consumers
• potential efficiency gains for domestic producers as they now have to compete with cheaper imports and therefore cut costs elsewhere

Question 9

Currency depreciation WIDEC

Answer 9

• weaker imports dear exports cheaper

Question 10

Benefits of currency depreciation

Answer 10

• increased employments in domestic & exporting industries
• increased net trade -> economic growth

Question 11

Negatives of currency depreciation

Answer 11

• SRAS may shift to the left as firms face higher costs
• higher DP & CP inflation (due to econ growth and SRAS fall)

Question 12

The Marshall-Lerner condition states that

Answer 12

• a currency depreciation will only correct a current account deficit if PEDx + PEDm > 1

Question 13

What do economists say happens in the short term when a currency depreciates?

Answer 13

• they say that in the SR, the Marshall-Lerner condition is not met as demand tends to be inelastic for both exports and imports
• this may be due to the time taken to adjust to changes currency value
• consumers may not comprehend the currency value change and therefore not change their behaviour accordingly
• it may also take foreign nations time to realise goods from e.g. the UK have become cheaper

Question 14

What effect is a result of net exports being inelastic in the short run?

Answer 14

• the J-Curve effect