4.1.8 Exchange Rates Flashcards

Question

What are the key problems with Competitive devaluations

Answer 1

* can be seen by other countries as a form of trade protectionism that invites some form of retaliatory action such as an import tariff * makes it harder for other countries to export negatively affecting their growth rate which in turn can damage the volume of trade that takes place between nations * go against the principles of trade based on comparative advantage

Answer 2

* The Government/central bank fixes the currency value * Pegged exchange rate becomes official rate * Adjustable Peg

Answer 3

External value is pegged to one or more currencies (known as the anchor currency) The central bank must hold sufficient foreign exchange reserves in order to intervene in currency market to maintain the fixed peg

Answer 4

They may need to buy domestic currency using foreign currency

Answer 5

1. Price of exports in international markets 2. Cost of goods bought from overseas 3. Revenues and profits earned overseas 4. Converting cash receipts from customers overseas

Answer 6

* Businesses earning substantial profits in overseas currencies * Businesses exporting into international markets

Answer 7

* Business importing good/serivces * Overseas businesses trying to compete in the domestic market

Answer 8

Strong Pound Imports Cheaper Export Dearer

Answer 9

a cut in interest rates

Answer 10

large trade deficit

Answer 11

Higher import prices feed into increased consumer prices help a country to avoid deflation and it also lowers real interest rates threatens real living standards especially for groups with weak bargaining power for wages

Answer 12

A weaker currency is usually a stimulus to GDP growth due to higher net exports But this depends on the price elasticity of demand for exports Also, many exports are made from imported components which will have become more expensive as a result of the depreciation (capital goods)

Answer 13

A more competitive currency will help to increase domestic production and perhaps create a positive export multiplier effect which will further stimulate aggregate demand and jobs.

Answer 14

Trade deficit may grow in initial period after depreciation This is because the price elasticities of demand for exports & imports are likely to be inelastic in the short term The impact on export sales also depends in part on the strength of GDP growth in key export markets

Answer 15

Should help to improve profitability because a fall in the value of the Pound increases the overseas earnings of UK companies in foreign currency which will now be worth more in Pounds

Answer 16

Depreciation is similar to a cut in interest rates therefore an expansion of monetary policy Therefore reduced price levels for businesses but there are risks too – including higher costs of importing components, raw materials and prices of important capital technologies.

Answer 17

Depreciation of a currency makes a country’s FDI assets appear more valuable when converted into the domestic currency Likewise, FDI liabilities (i.e. investment in UK) appear less valuable to overseas investors. This can ultimately therefore reduce inwards FDI.

Answer 18

* A depreciation could result in exporters reducing the price of goods/services sold overseas * This makes UK exports relatively cheaper in overseas markets - export prices fall leading to improved competitiveness * UK price of imported products will increase * A rise in import prices will make domestic producers in the UK appear relatively more competitive in price terms

Answer 19

1. Time lags for consumers/businesses to respond 2. Scale of change in the exchange rate 3. How long the change lasts for 4. Price elasticity for imports/exports (J-curve) 5. Multiplier or accelerator affects 6. When in the economic cycle the change occurs 7. Type of economy 8. Degree of openness the economy has

Answer 20

* reduces the need for central bank to hold large currency reserves * Freedom to set monetary policy interest rates to meet domestic objectives * May help imported inflation * Insulation for an economy after an external shock * Partial automatic correction of a current account deficit * Less risk of a currency becomes significantly over/undervalued

Answer 21

* No guarantee that floating exchange rates will be stable * Volatility in a floating currency might be detrimental to attracting inward investment * A lower (more competitive) exchange rate doesn't necessarily correct a BoP deficit * consider J curve theory and the importance of non-price competitiveness

Answer 22

* Certainty of currency value gives confidence for inward investment from overseas businesses * Reduced costs of “currency hedging” for businesses such as airlines * Currency stability helps to control inflation * A stable currency can lead to lower borrowing costs * Imposes responsibility on government macro policies * Less speculation in the currency market if the fixed exchange rate is regarded by traders as credible

Answer 23

* Reduced freedom to use interest rates for other macro objectives * Many developing countries do not have sufficient foreign currency reserves * Difficult for countries to use a competitive devaluation of their fixed exchange rate – this creates political tensions and might lead to a protectionist response * Devaluation of a fixed exchange rate can lead to a surge in cost-push inflation – this is damaging for competitiveness and has regressive effects on poorer families

Answer 24

for developing countries wanting to control inflation

Answer 25

Export-dependent economies may favour a managed floating rate e.g. to offset fluctuating world prices

4.1.8 Exchange Rates Flashcards

(51 cards)