2) Exchange rates: an introduction -MMT

Question 1

what are the 4 functions of money?

Answer 1

• acts as a medium of exchange
• a store of value
• a measure of value
• a standard deferred payment

Question 2

what is the most important function of money? why?

Answer 2

medium of exchange - money is used as an accepted means of payment when we buy goods and services, quite often goods and services are exchanged between economic agents in different countries

Question 3

what does “currency” mean?

Answer 3

the system of money used in a country

Question 4

what is the currency in the UK and US?

Answer 4

the £ sterling, the US is the US$

Question 5

how are currencies measured?

Answer 5

for historic reasons, most of these currencies use their own denomination, have their own system of measuring money

Question 6

what is an exchange rate? (x rates)

Answer 6

is the price of one currency in terms of another currency

Question 7

what is a fixed exchange rate?

Answer 7

happens when 2 currencies will always be exchanged at the same price

Question 8

how are floating exchange rates determined?

Answer 8

determined by the private market through supply and demand

Question 9

what is the private market called when dealing with floating exchange rates?

Answer 9

the FOREX (Foreign Exchange Market)

Question 10

how does the FOREX determine the value of the floating currency?

Answer 10

by how much of that currency is being demanded and supplied on the FOREX

Question 11

why is the x-rate diagram different to usual?

Answer 11

one of the few times in Macroeconomics that we use Microenconomics labels and terminology

Question 12

how do you draw an x-rate diagram?

Answer 12

• The x-rate is the price (how many US$ we get for £1)
• D is the demand for £s
• S is the supply of £
• The quantity of £s being traded

Question 13

how can floating x rates be shown on a diagram?

Answer 13

• P1 is the equilibrium X-rate (P of US$ to £1)
• An increase in the D for the £ will shift D curve for £s to the right, making the £ stronger against the US$
• a decrease in D for £s will shift D to the left, making the £ weaker against the US$

Question 14

floating x rates, what does an increase in D mean?

Answer 14

• An increase in the D for the £ will shift D curve for £s to the right, making the £ stronger against the US$

Question 15

floating x rates, what does an decrease in D mean?

Answer 15

• a decrease in D for £s will shift D to the left, making the £ weaker against the US$

Question 16

How do you show fixed rate on a diagram when the £ is priced too high? (above equilibrium)

Answer 16

• to ensure the fixed rate that they want, the Bank of england will need to demand more £s
• they go on the FOREX buying £s and paying for them using some of the US$ that they keep in their reserves
• this brings the demand for £ back in line with the S of £s, restoring equilibrium

Question 17

how do the Bank of England demand more £s?

Answer 17

go on the FOREX buying £s and paying for them using some of the US$ that they keep in their reserves

Question 18

How do you show fixed rate on a diagram when the £ is priced too low? (below equilibrium)

Answer 18

• to ensure the fixed X-rate that they want, the Bank of england will need to supply more £s onto the market
• to do this they will go on the FOREX selling £s, using those £s to buy more US$ building up their reserves
• this brings the supply of £s back in line with the D for £s, restoring equilibrium

Question 19

how do the Bank of England supply more £s onto the market?

Answer 19

• to do this they will go on the FOREX selling £s, using those £s to buy more US$ building up their reserves