exchange rates flashcards
(19 cards)
What is the exchange rate?
the external price of the currency , usually measures against another currency
What is a freely floating exchange rate?
an exchange rate regime where the currency is determined solely by the demand for and the supply of the currency
Why does a depreciating exchange rate mean that UK exports are more competitive?
What are the advantages of a floating exchange rate?
1)the central bank doesn’t need to hold large foreign reserves because there is no specific currency target
2) can correct trade imbalances, achieving current account equillibrium
3) interest rates ca be used as domestic monetary tools
What are the disadvantages of floating exchange rates
why is making it easier to control inflation an advantage of floating exchange rates?
It prevents the economy from importing inflation from the rest of the world. If inflation is occurring elsewhere, the floating exchange rate would appreciate as domestic goods are more competitive and demand increases. This appreciation lowers the prices of imports to prevent imported inflation.
Why is the ability to pursue an independent monetary policy an advantage of floating exchange rates
With a floating exchange rate, monetary policy can be used solely to achieve domestic policy objectives. This ensures monetary policy is not changed due to the events in the outside world and is solely decided based on the needs of the domestic economy.
what policy objectives can exchange rates achieve
1) reduce impact of recession
2)curb inflation
3)current account equillibrium
what are the disadvantages of floating exchange rates?
1)adverse effects of speculation and capital flows
2)uncertainty/volatility
3) may worsen inflation
why is speculation a disadvantage of floating exchange rates?
in the short run, currencies are extremely vulnerable to hot money movements into or out of currencies
- more opportunity for arbitrage
why is uncertainty a disadvantage of floating exchange rates?
-businesses trying to pin for the future are unable to make accurate predictions
- it is difficult to assess the exact level of return and risk which reduces international investment
what does inflation mean for trade?
it reduces international competitiveness and worsens the current account
what are fixed exchange rates?
an exchange rate regime which is fixed at a certain level by the country’s central bank and maintained by the central banks intervention in the foreign exchange rate market
how do fixed exchange rates work?
the central bank announces a central peg, with limits just above and below the central peg. Market forces determine the currency’s day-to day exchange rate
what are the advantages of fixed exchange rates?
1)certainty and stability in forex markets
2)imposes sensible government policies on inflation
3)reduces speculation
what are the disadvantages of a fixed exchange rate?
1)indépendent monetary policy cannot be undertaken
2)high levels of foreign reserves are required to maintain confidence in the currency
3) can lead to unemployment if interest rates have to rise to defend the currency
how can governments intervene to influence the exchange rate?
-the central bank can purchase or sell their own currency on the foreign market to offset excess supply or demand
-bank rate can be raised or lowered
what is a currency union?
an agreement between a group of countries to share a common currency, and usually have a single monetary and foreign exchange policy
