Final Exam Review Flashcards
(25 cards)
Long Run Exchange Rate Graphs
Short Run Exchange Rate Graphs
“Extra” Graph
What type of exchange rate system are these for?
Relative Price Levels (dom.) rise, ⬆️
Relative Productivity Levels (dom.) rise, ⬇️
Consumer Preferences (dom.) dom., ↙️
Trade Barriers (dom.) rise, ↙️
Economic Growth (dom.) rise, ↗️
Interest Rates (dom.) rise, ⬇️
Currency Expectations (dom.) depreciate, ↖️
Relative Inflation (dom.) rise, ⬆️
Floating/flexible exchange rate system
The Bretton Woods agreement of 1944 established a monetary system based on…
…gold and adjustable pegged exchange rates
As a policy instrument, currency devaluation may be controversial since it…
…imposes hardships on the exporters of foreign countries
If Mexico fully dollarizes its economy, it agrees to…
…replace pesos with U.S. dollars in its economy
Proponents of freely floating exchange rates maintain that…
…the system allows policy makers freedom in pursuing domestic economic goods
A potential limitation of freely floating exchange rates is that…
…exchange rates may experience wide and frequent fluctuations
Impossible Trinity
Top: Free Capital Flows
Bottom Left: Fixed Exchange Rates
Bottom Right: Independent Monetary Policy
Left: Hong Kong
Right: U.S.
Bottom: China
Advantages of Fixed Exchange Rates
- Simplicity and clarity of exchange rate target
- Automatic rule for the conduct of monetary policy
- Keeps inflation under control
Disadvantages of Fixed Exchange Rates
- Loss of independent monetary policy
- Vulnerable to speculative attacks
Advantages of Floating Exchange Rates
- Continuous adjustment in the balance of payments
- Operate under simplified institutional arrangements
- Allow governments to set independent monetary and fiscal policies
Disadvantages of Floating Exchange Rates
- Conducive to price inflation
- Disorderly exchange markets can disrupt trade and investment patterns
- Encourage reckless financial policies on the part of government
When money supply FALLS in the domestic country (relative), interest rates ____ and the dollar _____
rise, appreciates
Countries choose an exchange rate system (trinity) largely based on…
…global economic trends
To prevent a depreciation in currency, purchase the excess supply of ____ currency with ____ currency.
To prevent an appreciation in currency, purchase the excess supply of ____ currency with ____ currency.
domestic, foreign
foreign, domestic
Market equilibrium: floating exchange rates adjust automatically based on ____, facilitating market equilibrium.
market supply and demand
Bretton Woods
A simplified exchange rate system where it is understood that the par value of the currency will be changed occasionally in response to changing economic conditions. (When the U.S. abolished the gold standard, support for BW disappeared, $ floating)
Fixed exchange rates…
…create a loss of independent monetary policy
Central banks use monetary policy to stabilize exchange rates:
- Expanding MS (____ interest rates) used to offset currency ____
- Contracting MS used to offset currency ____
lowering, appreciation, depreciation
Currency Manipulation
The purchase or sale of a currency on the exchange market by the fiscal or monetary authority in order to influence the value of that currency
Internal balance
External balance
Overall balance
Full employment, no inflation
Neither current account deficit or surplus
Combo of above
Other goals
Long-run economic growth and reasonably equitable distribution of national income
Expenditure changing policies
Expenditure switching policies
Alter aggregate demand (fiscal and monetary policy)
Modify direction of demand (fixed and managed floating exchange rates)
Effectiveness in Promoting Internal Balance for an Economy (high capital mobility)
Floating
Fixed
Monetary policy more effective, fiscal less effective
Monetary less effective, fiscal more effective
Plaza Agreement (1985)
Dollar was overvalued and twin U.S. deficits (trade and federal budget) were too large. Specific pledges on macroeconomic policy, agreed to initiate coordinated sales of dollars
