Exchange rates Flashcards
(19 cards)
What is an exchange rate?
The price of one currency in terms of another.
What is a floating exchange rate system?
Where the currency’s value is determined by market forces of supply and demand, without government intervention.
What is a fixed exchange rate system?
Where the currency is pegged to another (e.g. USD or EUR), and maintained by the central bank.
What is a managed float?
A system where the exchange rate mainly floats, but the central bank occasionally intervenes to stabilise it.
What is appreciation?
An increase in the value of a currency (e.g. £1 = $1.30 → £1 = $1.40).
What is depreciation?
A decrease in the value of a currency (e.g. £1 = $1.30 → £1 = $1.20).
What causes a currency to appreciate?
• High interest rates
• Strong exports (demand for currency)
• Inward FDI
• Speculative inflows
What causes a currency to depreciate?
• Low interest rates
• Trade deficit
• Political instability
• Capital flight
What are hot money flows?
Short-term capital flows based on interest rate differences and expected currency changes.
What are the effects of a depreciation?
• Exports cheaper → more competitive
• Imports more expensive → cost-push inflation
• Improves current account (if demand is elastic)
• Boosts tourism & foreign investment
What are the effects of an appreciation?
• Exports more expensive → less competitive
• Imports cheaper → lower inflation
• Worsens current account
• Could lower GDP growth
What factors influence the impact of an exchange rate change?
• Elasticity of demand for exports/imports (Marshall-Lerner condition)
• Presence of imported raw materials
• Time lags (J-curve effect)
• Global conditions (e.g. recession abroad)
What is the Marshall-Lerner condition?
A depreciation will improve the current account if the sum of PED for exports and imports > 1.
What is the J-Curve effect?
After a depreciation, the current account may worsen short term (contracts fixed in old prices) but improve in the long run.
How can monetary policy affect the exchange rate?
• Higher interest rates attract hot money → appreciation
• Lower interest rates → depreciation
What are the pros of a weak exchange rate?
• Boosts exports
• Helps reduce a trade deficit
• Can stimulate growth
What are the cons of a weak exchange rate?
• Imported inflation
• Reduced consumer purchasing power
• Foreign debt repayments more expensive
What is currency manipulation?
When a country deliberately devalues its currency to boost exports (e.g. via central bank intervention).
Why do exchange rate fluctuations matter globally?
• Affects trade balances
• Can spark ‘currency wars’
• Influences investment flows and inflation worldwide
