Exchange Rates 🧟♀️ Flashcards
(45 cards)
1
Q
How can you measure exchange rates?
A
- nominal exchange rate
- real exchange rate
- bilateral exchange rate
- effective exchange rate
2
Q
What is nominal exchange rate
A
- direct comparison of currencies
3
Q
What is real exchange rate
A
- adjusts nominal ExR to take price levels into account - shows true value of currency
4
Q
What is bilateral exchange rate
A
- ExR between two countries
- e.g £:$
5
Q
What is an effective exchange rate
A
An ExR measured against a basket of currencies of trading partners
- weigh each country by the proportion of your trade you do with it
- gives an overall summary of the value you of currency against others
6
Q
What is an adjustable peg?
A
- fixed in the short term but regularly adjusted to a new fixed rate
7
Q
What is a crawling peg?
A
- currency’s value is allowed to adjust gradually over time in response to economic conditions.
8
Q
What is a managed float
A
- Floating but central bank intervenes to avoid large fluctuations
9
Q
What is a managed float
A
- Floating but central bank intervenes to avoid large fluctuations
10
Q
Exchange rate band systems
A
- free float with a permitted band, intervention takes place if ceiling or floor is reached
11
Q
What is a free floating exchange rate?
A
Value of one currency in terms of another is determined without interference; it is determined by the forces of demand and supply
- trade flows and capital flows affect the exchange rate
- no target exchange rate
- no need for official intervention in the currency market by central bank
12
Q
What determines the demand of the £?
A
- Speculation on the future of value of the £
- Interest rates
- FDI inflows
- Exports
- Government ‘open market’ operations (selling forex reserves and buying £s) in the FOREX market
- Inflation rates (demand for exports)
13
Q
What may cause short run buying of £?
A
Speculation that £ will rise
14
Q
What may cause long run buying of £s?
A
- hot money inflows (UK interest rates are rising)
- FDI rising
15
Q
What may cause an increase in exports (irrelevant to exchange rate)
A
- derived demand
16
Q
What are the 5 main arguments for a floating exchange rate?
A
- Reduced need for currency reserves
- Useful instrument of macroeconomic adjustment
- Partial automatic correction for a trade deficit (however, dependent on J curve)
- Reduced risk of currency speculation
- Freedom for domestic monetary policy
17
Q
Why is it good to have a reduced need for currency reserves?
A
- little requirement for central bank to hold large scale reserves of foreign currency to use in possible intervention in the markets
18
Q
What is the benefit of having a floating exchange rate for macroeconomic adjustment
A
Depreciation can increase exports and therefore stimulate growth
- however, this assumes that this isn’t diluted by higher wage claims or export prices
19
Q
How does a floating exchange rate reduce currency speculation?
A
- currency market speculators often target an exchange rate target they believe to be fundamentally over or undervalued
20
Q
Why is freedom for domestic monetary policy good
A
- allows short term interest rates to be set to meet domestic MEO such as stabilising growth or controlling inflation
21
Q
Are floating exchange rates always volatile?
A
No
- Sterling
- businesses have learnt to cope with modest fluctuations - which is helped by having a flexible labour market
22
Q
What are the disadvantedges of floating exchange rates
A
- Can lead to volatile exchange rates
- can be bad for business planning - uncertainty
- can make it more difficult to conduct businesses abroad - If an ExR falls it could lead to cost push inflation
- FoPs more expensive - Speculation can lead to an artificially high exchange rate (X-M could worsen)
- could lead to imported cost push inflation if PED for M is inelastic
23
Q
Fixed exchange rates
A
- the value of a currency is fixed to the value of another currency or certain commodities
24
Q
How is the value of a currency maintained?
A
- The central bank will either set interest rates to increase hot money inflows
- Buy and sell own currency in forex markets
- Restrict amount of currency allowed to leave its economy
25
What is a revaluation?
- when the value of a currency is increased
26
What are open market operations?
- buying or selling currency on the forex market
27
What are the benefits of fixed er
1. Stability; reduced uncertainty
- more certainty for exporters when pricing and businesses spend less on currency hedging
2. Reduced costs of trade
- firms no longer need to hedge against exchange rate movements
3. Increased investments (more attractive)
4. Forces domestic firms to be internationally competitive as there is no adjustment made on their behalf
5. ER can be adjusted
28
What are disadvantages of fixed ER
1. Opportunity cost: high levels of foreign currency reserves
2. Loss of monetary policy
3. Fixed ExRates hard to maintain
4. Speculation
- currencies can become over or undervalued (they wont match domestic conditions and trade patterns) - speculators will buy or sell the currency causing huge volatility
5. No automatic correction - may cause firms to cut costs during an appreciation
6. Retaliation
29
How does a fall in the value of a currency affect consumers?
- Increase in price of imports could lead to lower living standards (lower PPP,) decreases disposable income
- increase in employment in the export industry as derived demand for export increases (depends on PEDx)
30
How does depreciation affect firms
- Price of imported FoPs increase, SRAS (shifts left and up). Oil and energy contribute largely (UK imports most of these)
- higher revenues as foreign demand for exports increases (depends on PEDx)
Eval: depends on firms - exporters benefit, firms that import FoPs suffer
31
What is the effects of a depreciation on the government?
Tax revenues fall
- disposable income falls so VAT revenue falls
- Corporation tax revenue falls (depends on firm nature)
- Debt in foreign currency increases
32
How can economic growth be affected by depreciation?
- export led growth
- cost of imported fops increases - opposite effect?
33
How is unemployment affected by deprivation?
- export industry grows
- firms that rely on import fops have to cut costs - lay off workers
34
How is inflation affected by a depreciation?
- costs push inflation (oil. Energy)
- demand pull (X-M) increases
35
What is the J curve an eval for
- how a depreciation will reduce the current account deficit
36
How can a depreciate reduce income inequality
- Exporting industry grows
- more labour needed, putting upward pressure on. Wages
- trickle down
Eval:
- inflation can reduce PPP of low income households - particularly those who rely on imported goods
37
What is the effect of a depreciation on public finances?
- debt bad
- export led growth could increase tax revenues and improve budget position
38
What is a monetary union?
When a group of countries share:
1. A common market: where goods, services, labour are able to move freely
2. A common currency: eliminating exchange rate fluctuations within the union
3. Governance by a common central bank: monetary policy for entire union
39
When was the Euro formed
1999
40
What are the benefits of a monetary union
Exchange rate risk
- avoids fluctuation in currency values (eliminates risk)
- which avoids uncertainty in trade and investment
Price transparency and competition
- easy comparison - enhancing completion
Greater economic integration and stability
Global influence
41
Drawbacks of monetary union
Individual countries cannot set own interest rates or implement monetary policy tailored to specific conditions
- imbalances (Greece)
- cant stimulate growth
- harder for debt heavy countries
Risk of asymmetric shocks
Need to adhere to strict fiscal rules, which limits budget deficits and public debt levels.
- can restrict countrys ability to increase public spending during recession
42
Describe the change in the value of the £ before and after brexit
- Before and after referendum day the GDP/USD dropped from 1.3 to 1.08
- fluctuated massively until we left in 2021
- slight growth and recovery to 1.2 but still influenced by uncertainty
43
Example of fixed er
- Ecuador + Zimbabwe (fixed to $)
-
44
Example of managed floating system
- South Africa
- japan
- Sweden
- Mexico
45
What is Dutch disease?
- country becomes a significant commodity producer in a short amount of time
- fast appreciation -> reduction of competitiveness
- occurred for the non-oil sectors in Venezuela and Nigeria
