Exchange rate systems (Macro)

Question 1

What is the exchange rate?

Answer 1

Price of one currency expressed in terms of another.

Question 2

What is a floating exchange rate system?

Answer 2

Where the government makes no attempt to change the value of the currency

Question 3

What will influence exchange rates with FER?

Answer 3

-Interest rates moving (Demand)
-Foreign trade, increased demand for imports means an outflow of pounds (Supply)
-Relative inflation (Demand for exports falls)
-FDI (Demand for pound)
-Expectations

Question 4

Advantages of a floating exchange rate?

Answer 4

-Monetary sovereignty (interest changed based on individual nations need)
-Automatic adjustment to current account
-No need for extensive stock of foreign currency for open market operations.

Question 5

What is the open market operations?

Answer 5

Direct intervention into foreign currency market to influence demand and supply of that currency

Question 6

Disadvantages of a floating exchange rate?

Answer 6

-Uncertainty for business
-Overvalued currency makes it hard for those to export

Question 7

What is a fixed exchange rate?

Answer 7

Where the government intervenes to stabilise a currency value against others.

Question 8

What are the methods of intervention?

Answer 8

-Monetary policy
-Open market operations (buying/selling foreign currency)
-Capital controls on amount of currency which can enter/leave economy

Question 9

Advantages of a fixed exchange rate?

Answer 9

-Easier trade for businesses, increased exports
-Monetary discipline, less likely to be cuts in interest which leads to demand pull inflation

Question 10

Disadvantages of fixed exchange rates?

Answer 10

-Loss of monetary sovereignty
-Large reserves of foreign currency needed
-Lack of adjustment to current account imbalances

Question 11

What is a currency union?

Answer 11

A group of countries with the same currency (EU and Euros)

Question 12

Arguments for currency union?

Answer 12

-Business certainty
-No costs to convert
-Wont need to worry about over/undervaluations
-Greater price transparency

Question 13

Arguments against currency union?

Answer 13

-Lack of control for individual countries to control policy
-Business unable to compare with lower cost producers which are a part of the union (no benefit from falling exchange rate)
-Wide use of fiscal policy
-Bailing out if in debt