Topic sheet 6 Flashcards
What is meant by a fixed exchange rate?
-When the value of one currency is fixed in terms of another target currency.
Why might a country want to fix exchange rate?
What is meant by devaluation or revaluation?
§Devaluation is when a country deliberately reduces the exchange exchange rate in a fixed system
-Revaluation is when a country deliberately increases the exchange rate.
What is meant by a floating exchange rate system?
-when the exchange rate is determined by the forces of supply and demand.
What are 4 factors that would increase demand for the £.
- An increase in exports as this would increase the demand for sterling.
- an increase in interest rates as there would be a hot money flow into the UK.
- speculation that the currency will appreciate.
- an increase in tourism.
What are the 4 factors that would increase the supply of sterling?
- A speculation that GPB would fall
- An increase in imports for the UK.
- decrease in interest rates.
- Increase in tourism abroad.
What can cause an exchange rate to appreciate?
-Anything that causes an increase in the demand for a currency.
What can cause an exchange rate to depreciate?
-anything that causes an increase in the supply of a currency or a decrease in demand.
What is the difference between devaluation and depreciation?
- Depreciation/ appreciation is when a currency gets stronger or weaker but due to the market forces.
- Devaluation/Valuation is when a currency gets stronger as a result of deliberate intervention.
What is meant by hot money?
-Money that is moved around the globe in search of the best exchange rate or interest return.
What are the advantages and disadvantages of a floating exchange rate?
- A floating ER always adjusts so there is 0 on balance of payments.
- Helps a country react to external shocks, eg high inflation.
- Monetary policy is free to serve the interests of the domestic economy.
- Does not need to worry about reserves?
What are the advantages and disadvantages of the fixed exchange rate?
-A fixed exchange rate creates stability and predictability, whereby trading can happen with one less variable.
This is when UK companies have a lot of income generated from abroad.
What is meant by a managed exchange rate?
-A mix between allowing the currency to float and government intervention.
Eg it is able to float between parameters.
How can the government or central bank influence exchange rates?
In the UK the central bank is independent of the government.
In some countries the government may instruct the bank to buy the currency.
What are the consequences of a competitive devaluations and depreciations?
What are the theories against this?
- In theory a depreciation or devaluation should cause which will make them look cheaper to foreign consumers which will benefit the balance of payments.
1. J curve, suggests that demands and exports are inelastic in the short run so it may cause a worsening before it improves.
2. Marshall Lerner condition, because the sum of elasticities of demand for imports and exports are equaled to 1. If demand for exports is sensitive to a price change there will be proportionally more imports bought.
