Macro: Trade Flashcards
Exchange Rate
The value of a currency in a foreign currency
Determinants of the exchange rate
Anything that affects the domestic or international supply or demand for the currency
E.g. Interest rates,FDI/other investment,Inflation,foreign trade
What is a floating exchange rate?
Determined by the market
What is a fixed exchange rate?
Where the government or central bank of a country set the exchange rate
Changes in the exchange rate?
Increase/Stonger/Appreciation- e.g. In the UK an appreciation would be an increase in the amount of $ for a £
Decrease/Weaker/Depreciation- decrease in amount of $ for a £
Terms of Trade
The relationship between the price of the things we normally import vs the price of things we normally export
Terms of Trade= index average export prices/ index average import prices
What do terms of trade tell us?
It tells us the volume of exports needed to purchase a given number of imports
What affects the terms of trade?
Anything that affects the value of imports or exports
Terms of trade affecting BOP
When export prices rise more than import prices- Terms of Trade INCREASE and the current account on the balance of payments improves
When Import prices rise higher than Export prices-Terms of trade-DECREASE and the current account on the balance of payments worsens
Absolute and comparative advantage?
Absolute advantage- a country can produce more of a good with the same amount of resources (e.g. Due to lower costs)
Comparative advantage- a country with the lowest opportunity cost has a comparative advantage
Effect of interest rates on exchange rate
Increase- Appreciation (more demand less supply)-
Decrease- depreciation (less demand mote supply)
Imports and exports affecting exchange rate
Increase in D for imports will weaken the pound as more demand for other currency
Increase in D for exports will increase D for pound and appreciate the value
Advantages of fixed exchange rate
Easier trading for businesses
Monetary discipline-keeping interest rates In line with the economy it is being fixed against gives monetary policy added credibility
Less likely to be cuts in interest rates might be inflationary purely to boost a government’s popularity
Disadvantages of fixed exchange rate
Loss of monetary sovereignty
Large reserves of foreign currency may be needed for government intervention
Lack of adjustment to current account imbalances
Advantages of a floating exchange rate
Monetary sovereignty- interest rates set on the need of the uk economy alone rather than changing them to have to stabilise the exchange rate
Automatic adjustment to the current account balance - a large deficit on the current account would mean a large outflow of pounds, which should lead to the exchange rate falling, thus automatically leading to restoring export competitiveness
There Is no need for the government to hold extensive stocks of foreign currency for open market operations to influence a currencies value
(Open market operations=direct intervention into the foreign currency market to influence the demand for and supply of that currency)
