Floating Exchange Rate changes- Appreciations and Depreciations

Question 1

What happens during a currency appreciation?

Answer 1

The value of the currency increases relative to others (e.g. £1 = $1.80 → £1 = $1.60).

Question 2

Causes of currency appreciation?

Answer 2

Higher relative interest rates attract foreign capital

Speculators anticipate a rise in the currency’s value

Increase in Foreign Direct Investment (FDI) inflows

Rising foreign incomes boosting demand for domestic currency

Improvements in competitiveness (lower unit labour costs, low inflation, investment)

Question 3

What happens during a currency depreciation?

Answer 3

The value of the currency decreases relative to others (e.g. £1 = $1.60 → £1 = $1.40).

Question 4

Causes of currency depreciation?

Answer 4

Lower interest rates relative to other countries

Speculators expect the currency to fall

Firms or investors moving money away from the country

Lower domestic incomes reducing demand for the currency

Question 5

What are the effects of an appreciation on the economy?

Answer 5

Exports become more expensive, reducing demand

Imports become cheaper, increasing demand

Could lead to a current account deficit

Potential lower inflation due to cheaper imports

May reduce economic growth

Question 6

What are the effects of a depreciation on the economy?

Answer 6

Exports become cheaper, boosting demand

Imports become more expensive, reducing demand

Could help reduce a current account deficit

May cause import-led inflation (cost-push)

Could stimulate economic growth

Question 7

What role do speculators play in exchange rate changes?

Answer 7

They buy or sell currencies based on expectations, which can cause rapid appreciations or depreciations.