6) Consequences of Exchange Rate Changes - MMT

Question 1

how can floating rates be greatly impacted by changes in the interest rate, there is a … link between interest rates and exchange rates

Answer 1

positive

Question 2

as x rates are ultimately a price…

Answer 2

like all prices they will fluctuate with changes in demand and supply of the currency. Often this is determined by the confidence/faith/trust that speculators have in the economic performance of the country

Question 3

anything … will tend to lower the value of the x rate

Answer 3

negative

Question 4

what is the link between growth and devaluation of fixed rates/sustained depreciation of floating rates?

Answer 4

with help to drive growth in the economy

Question 5

why is the link between an increase in growth and devaluation of fixed rates/sustained depreciation of floating rates?

Answer 5

due to their impact on x and m

Question 6

how can a lower x rate improve international competitiveness?

Answer 6

as it makes exports more attractive relative to imports and therefore increasing growth (however this may depend on the type of economy)

Question 7

what can a higher/lower x rate in order to improve international competitiveness depend on?

Answer 7

depend on the type of economy

Question 8

a higher/lower x rate in order to improve international competitiveness depending on type of economy example

Answer 8

eg a developed economy like the UK relies greatly on strategic imports eg oil, may find that higher import prices could harm growth

countries for whom exports are the main drivers of their economy eg China, may prefer low x rates to continuously drive growth

Question 9

why is a stable x rate preferable to a highly volatile one?

Answer 9

due to uncertainty undermining confidence

Question 10

why is it bad if the x-rate is changing all the time?

Answer 10

it becomes very difficult for firms to maintain the prices at a stable level

Question 11

what is a major problem for countries with fixed rates?

Answer 11

the concept of imported inflation, if prices increase in countries that they trade with then they will tend to import those price increases into their economy

Question 12

in countries with floating rates, how can imported inflation be avoided?

Answer 12

by adjustments in the x rate, however, it is generally the case that a strong currency can help to limit the effects of inflation, a weak currency exposes the economy to more inflationary risk

Question 13

what does a strong currency mean for employment?

Answer 13

a strong currency may harm the export sector costing jobs

Question 14

what does a weak currency mean for employment?

Answer 14

a weak pound may benefit exporting businesses creating jobs (however this depends on the nature of the industry)

Question 15

why might a weak currency possibly not generate many jobs?

Answer 15

• it depends on the nature of the industry, eg capital intensive industries like car manufacture may benefit from a weak currency but not necessarily create too many new jobs
• it also depends on the duration of x-rate changes, eg if the x-rate increases one week but declines the next then businesses are unlikely to make any changes in investment or employment as a result
• long term changes in x-rate may have more of an impact

Question 16

what does a low currency mean for the balance of payments?

Answer 16

• a low currency will help to drives BoP current account trade surplus (imports are dearer)
• for this reason, countries like China are keen to keep their x-rate at artificially low levels to ensure that their huge current account surplus is protected

Question 17

what does a strong currency mean for the BoP?

Answer 17

often create a BoP current account deficit

Question 18

what is an example of strong currencies leading to surpluses in the financial account?

Answer 18

the USA imports large volumes from China; the strong US$ helps to enhance this trend by making Chinese imports relatively cheaper

however it depends on which side of balance of payments we look at, the current account or the financial account

Question 19

strong currencies lead to …. in the financial account of the BoP

Answer 19

surpluses

Question 20

weak currencies lead to …. in the financial account of the BoP

Answer 20

large deficits

Question 21

why do China have a financial account deficit?

Answer 21

China is awash with foreign currency (earned from their exports) and they use this foreign currency to invest huge sums overseas - a financial account deficit

Question 22

edt do other countries possess vast amounts of US$?

Answer 22

the USA imports so much, other countries possess vast amounts of US$s, they use this to invest in American financial assets - i.e the money ends up in Wall street!

Question 23

what does the size/extent of any change mean?

Answer 23

minor fluctuations have little effect, big fluctuations have big effects

Question 24

hour are exchange rates relevant to time?

Answer 24

how long any upward or downward trend is sustained for, obviously one day movements have less effect than one year trends

Question 25

how do time-lags with devaluation tie into trade deficits?

Answer 25

devaluations in the short-term might not reduce a trade deficit but in the longer term, when the impact of the lower currency has kicked in, they might reduce the deficit (J-curve effect)

Question 26

how does PED affect imports and exports? (short term)

Answer 26

the Marshall Lerner condition, which creates the J-Curve effect above. If the combined PED of x and m < than -1 (ie Price inelastic) then the change in value of x and m will be less than the change in rate

this is explained by the fact that in the short-term changes, changes in the x-rate may not impact levels of x and m by much, eg due to companies being tied in to contracts, lack of suitable alternatives etc

Question 27

how does PED affect imports and exports? (long term)

Answer 27

the Marshall Lerner condition, which creates the J-Curve effect above. If the combined PED of x and m < than -1 (ie Price inelastic) then the change in value of x and m will be less than the change in rate

in the longer term, demand for x and m will be much more sensitive to x-rate changes ie more elastic