Unit 16.3 Flashcards
What is a fixed exchange rate
A fixed exchange rate is where the value of two or more currencies has exchange rates that cannot change against each other.
what are the strategies for Maintaining Fixed Exchange Rates and Their Economic Impacts
Managing exchange rates through reserves:
Central bank buys local currency with foreign reserves to reduce supply when there’s too much.
This action keeps the exchange rate at the target, e.g., 2 dollars = 1 boople.
Howewver:
If imbalances last, foreign reserves may run low.
The bank or government must then find other ways to sustain the exchange rate, which could be problematic.
Raising Interest Rates: This attracts foreign investment as investors look for better returns, increasing demand for bople. Yet, high interest rates can slow down the economy, possibly leading to a recession.
Borrowing from Abroad: Getting loans in dollars and converting them to bople increases the demand for bople. But borrowing a lot can be costly and risky.
Limiting Imports: By using policies to reduce imports, Bopland decreases the supply of bople on the foreign exchange market. This could be done by making imports more expensive or harder to get. Though, this might upset other countries Bopland trades with and they might respond with their own restrictions, affecting Bopland’s exports.
What is devaluation
Government lowers currency value to maintain the exchange rate.
What is revaluation
Government raises currency value when it’s sustainable.
What is a managed exchange rate
A managed exchange rate is when a country’s central bank regularly checks the value of its currency and, if it’s going too high or too low, the bank steps in by buying or selling currencies to keep the value just right, not too fixed and not too freely changing.
Give a method of managed exchange rate
pegging is a method of managed exchange rate where a country fixes its currency’s value to another major currency like the US dollar or the euro. The central bank will then buy or sell currencies to keep the exchange rate within a certain range.
Consequences of undervalued currency
Exchange rate is set lower than the market equilibrium.
Makes exports cheaper and imports more expensive.
Can be used strategically to boost export industries and employment.
Considered an unfair competitive advantage by some.
Can lead to “dirty float” and cause inflation due to costlier imports.
Consequences of overvalued currency
Exchange rate is set higher than the market equilibrium.
Results in cheaper imports but more expensive exports.
Can harm domestic producers and employment.
Might lead to a trade deficit and payments difficulties.
Often leads to devaluation to correct the rate.
What is overvalued currecny
An overvalued currency is when a country’s money is more expensive than it should be, which makes its exports pricier and imports cheaper.
what is undervalued currency
An undervalued currency is when a country’s money is cheaper than it really should be, making its exports less expensive and imports costlier.
