Y1 Exchange Rates Flashcards
Exchange rate
The price of one currency in terms of another
Floating exchange rate
Determined by market forces in the Forex market
PRO- Interest rates are focused on inflation & growth
CON- Volatile
Reasons why demand/supply of a currency can change
Purchase of foreign goods/services
Tourism
Hot money flows
Purchase of foreign shares/bonds
Speculation
Gov intervention
Impact of exchange rate on an industry depends on
Exporter or importer
How dependent on trade
If raw materials are imported
Strength of foreign competition in domestic market
Currency involved
Effect of appreciation
Exports expensive & imports cheap, so less exports and more imports, so worse trade balance, AD decreases.
But also imported raw materials cheaper, so SRAS increases, cost-push inflation decreases.
How the gov can devalue the £
Buy foreign currency (so sell £)
Reduce interest rates (hot money out)
Marshall lerner condition
Trade balance will only improve from depreciation if PED for exports/imports is elastic
J curve effect
Depreciation may initially worsen trade balance but improve in the long run because firms need time to adjust
Balance of payments
Gov accounts which record financial transactions between UK and R.O.W.
Current account & Capital account
ALWAYS BALANCES
Usually measured in % of GDP
Current account (Van In Pea Soup)
Visible balance (goods)
Invisible balance (services)
Primary income (profits, dividends, interest)
Secondary income (foreign aid)
Capital account (Dust Pan Brush)
Direct investment flows
(foreign firm investing in UK)
Portfolio investment flows
(foreign firm buying UK shares/bonds)
Banking flows
(foreign currency reserves, hot money, interbank lending)
Export led multiplier
Increase in X results in more than proportional increase in AD
Long term impacts of trade deficit
Structural/Regional imbalance
Hysteresis
Reliance on borrowing
Reliance on imports
Less confidence, further fall in AD
Expenditure switching ( to fix trade deficit)
Import tariffs and other protectionism
Depreciation
Low relative interest rates
Issues with protectionism
Less economic welfare
Trade wars
Economic damage to foreign countries
Less need for specialisation/R&D
Motives for protectionism
Protect new or declining industries
Protect strategic industries
Protect non-renewables
Protect jobs
Improve trade balance
Devaluation in the UK
Despite a weak pound since 2008, our trade deficit has gotten worse. This is because of our inelastic PED for imports and slow growing X from low investment.
Policies to address BoP
As the current account deficit is counter cyclical it can be improved by reducing demand.
As we have a high MPM, lower incomes would mean far less M.
Long term solution is supply side policies, to increase X and reduce need for M
Weaknesses of UK exports
Productivity gap
Low investment
Lack of R&D
Lack of manufacturing
SSP to improve trade balance
Attracting FDI (low corporation tax) to increase X
Tax breaks to increase capital investment
Developing new areas
