Topic 7 - A Global Perspective Flashcards

Question

How is export-led growth a benefit of globalisation for more-developed countries (MDCs) ?

Answer 1

Globalisation allows countries to develop further through export-led growth and an export-led positive multiplier. For example, South Korea developed over many years via an export-led growth model.

Answer 2

Vulnerability to shocks Structural/regional unemployment Exchange rate volatility

Answer 3

By becoming more interdependent, the risk of contagion (an external event somewhere else in the world coming back to affect you) rises. Contagion makes a country more vulnerable to economic problems elsewhere. E.g. economic problems spreading through the Eurozone countries after the events of the financial crisis in 2008.

Answer 4

Domestic firms could be out-competed by competitors in LDCs with lower costs and close down. Because labour is a derived demand, this could lead to regional unemployment. E.g. the 'Rust Belt' in the USA suffered from losing its main industry of car manufacturing.

Answer 5

Volatile speculative flows of hot money are a feature of globalisation. Changes in interest rates can cause investors to take their money out of a currency in seconds. Frequent changes in exchange rates are hard to manage as an importer and an exporter. In 2011, the Swiss Franc changed in value vs the Euro by 30% in one day. Between 2014 and 2016, the Brazilian Real fell 50% vs Sterling. Exchange rate volatility can make it difficult for MNCs to plan.

Answer 6

Specialisation means countries often stop making products they need, to focus on producing the products they are better at. As a result, trade must happen with other countries, and an efficient exchange system is needed. Money is often used as this medium of exchange because everyone values money.

Answer 7

Free trade can allow countries to specialise in the goods they are most efficient at producing. Trade means that they can buy some goods from other countries, rather than producing them themselves. E.g. Finland with paper and Germany with cars

Answer 8

If a country produces sugar, it has an opportunity cost of production. The labour and capital used to make sugar cannot be used to make wheat at the same time. E.g. if Brazil can produce a lot of sugar cane per acre but not much wheat, and the US can produce a lot of wheat but not sugar cane, then the US has a lower opportunity cost of producing wheat than Brazil. This can be shown using production possibility frontiers (PPFs).

Answer 9

The US has a comparative advantage in producing wheat. Brazil has a comparative advantage in producing sugar cane. If both countries could specialise in producing the goods they had a comparative advantage in, then: The total world output of goods will rise. Brazil and the US can trade wheat for sugar cane, and they both benefit. Think of comparative advantage as what a country is least bad at - they all have to produce something!

Answer 10

A country has an absolute advantage in producing a good over another country if it uses fewer resources to produce that good. E.g. if Saudi Arabia can produce corn and oil more efficiently than the US, but can only produce 100 barrels of oil or 25 bushels of corn, the opportunity cost for Saudi of producing one barrel of oil is the loss of 0.25 bushels of corn. If the US lost a bushel of corn by producing one barrel of oil, then the US has a comparative, but not absolute advantage in corn.

Answer 11

Negative externalities such as pollution from freight. Risk of structural/regional unemployment because employers relocate. While international trade may benefit skilled workers, it can be bad for low-skilled workers. Low-skilled workers in developed countries compete against extremely low wage workers worldwide, which is unsustainable.

Answer 12

the free movement of goods and services cross-border between countries with no attempt from government to unfairly restrict imports from, or exports to, other countries

Answer 13

Improved allocative efficiency Higher global output Greater competition and choice Economies of scale

Answer 14

Free trade improves the efficiency of resource allocation because countries produce in sectors they are better suited to, rather than all goods and services. The more efficient use of resources leads to higher productivity and increasing total domestic output of goods and services.

Answer 15

Comparative advantage theory states that, if countries specialise in goods and services, have a lower opportunity cost of producing than other countries, and engage in free trade, they have the possibility of achieving an allocation of resources outside their initial PPF.

Answer 16

Free trade causes increased competition, which will lead to cheaper prices and higher consumer surplus. The reduction in prices increases real incomes, increases purchasing power and allows more goods and services to be bought. So this increases standard of living. Free trade brings down cost-push inflationary pressure. Free trade increases choice. Free trade allows countries to consume bananas even if they don’t have the climate for it.

Answer 17

Firms and countries can specialise in the production of a small range of good and services, and trade them with other countries. Because firms can focus on producing a few goods and services, there is scope for more economies of scale, lower LRAC, lower prices, higher consumer surplus and increased demand for goods.

Answer 18

In 2016, UK exports were valued at around £300bn. The main exports in the UK were financial services, cars, wholesale medicines, gas turbines, petroleum and gold. The leading recipients of UK exports are the USA, Germany, the Netherlands and France.

Answer 19

In 2016, UK imports were valued at around £500bn. The main imports were cars, vehicle parts, aircraft, gold, petroleum and wholesale medicines. The leading suppliers of imports to the UK are Germany, China, the USA and the Netherlands.

Answer 20

Since 2000 the UK has decreased its share of exports to the EU from 55% to 45%, taking advantage of the rapid economic growth of countries such as Brazil, China, Russia and India. As London grew as a financial hub from 2000-2008, there was an increase in financial services exported to the rest of the world. This slowed after the global financial crisis of 2008, but is still a major contributor to UK exports.

Answer 21

Since 2000, over 50% of UK imports have come from the EU. The rapid growth of China as an exporter has meant that lots of UK imports now come from China. The decline of the UK manufacturing industry has meant that we import lots more manufactured goods, including computers.

Answer 22

Between 1986 and 1998, the UK averaged a small trade deficit of around £5bn. This then grew until 2002 where it reached £30bn and has stayed roughly stable ever since

Answer 23

Emerging economies Changes in relative exchange rates Comparative advantage The growth of trade blocs

Answer 24

Emerging economies like China started producing lots of manufactured goods. They had far lower labour costs than developed markets like the UK and USA. This led to deindustrialisation in the developed world because jobs relocated from developed countries to developing countries. Emerging economies like China export a lot of manufactured goods to countries all over the world.

Answer 25

Changes in relative exchange rates can adjust trading patterns. Nations like Greece, who joined the Euro, saw their relative exchange rate appreciate because they were part of a larger, more successful economy and currency. This would have discouraged the purchase of Greek exports internationally. When Brazil had a political crisis in 2015, its nominal and real exchange rate declined by over 30%. Holidays to Brazil became more affordable and popular because the Brazilian Real became so cheap

Answer 26

David Ricardo's theory of comparative advantage explains why nations specialise in producing different products. Many developing nations have comparative advantage (and specialise in) producing primary products (commodities) like Brazil. They export these primary products to nations that have specialised in manufacturing products (the secondary sector) like China. These exports are bought internationally. Nations like the USA have specialised in tertiary services, however, these are consumed more in the USA. This is one reason for the USA and UK's current account deficits.

Answer 27

Trading blocs and bilateral trading agreements like the EU (or European Economic Area) and NAFTA reduce tariffs and barriers to trade within trade blocs. The EU encourages tariff-free trade between members but imposes a common external tariff on goods from outside the EU. This encourages the consumption of EU goods and discourages trade with nations outside of these agreements because they are at a relative pricing disadvantage.

Answer 28

David ricardo

Answer 29

Netherlands

Answer 30

Appreciated

Answer 31

the price of a nation's exports relative to the price of a nation's imports

Answer 32

A nation's Terms of Trade = (Average export price index ÷ Average import price) X 100

Answer 33

A nation's terms of trade have improved if they can buy more imports for a given amount of exports. Brazil exports oil. When the oil price is very high, Brazil can buy more consumer goods and machinery (capital goods) with a given amount of oil exported because the value of their export index rises.

Answer 34

If an increase in import prices is larger than an increase in export prices, then a nation's terms of trade have worsened.

Answer 35

Anything affecting exports and imports will affect terms of trade. A technological advance in the nation will allow it to export either higher quality goods (worth more money) or export higher volumes of goods. A tariff imposed by another nation will automatically worsen a nation's terms of trade. A commodity price boom could improve a commodity exporter's terms of trade and worsen a commodity importer's terms of trade. High inflation without a change in exchange rate will likely improve a nation's terms of trade. But often, a country's exchange rate worsens if there is high inflation. An increase in the value of a nation's currency will lower the price of imports in the country, improving terms of trade.

Answer 36

Worsening terms of trade will mean that a nation can afford to import a lower value of goods from abroad. If the nation continues to import as they did before, their current account deficit will get worse. A nation's domestic industry may become more price competitive relative to imported goods and this may increase tax revenues for the government. Worsening terms of trade may cause cost-push inflation as either more expensive domestic goods have to be purchased or more expensive imports still have to be bought.

Answer 37

Regional trade blocs are intergovernmental groups that reduce the barriers to trade in their region

Answer 38

COMESA is a grouping of 19 countries in east and southern Africa. Its members include Kenya, Libya, Egypt, Madagascar, Mauritius and Zambia.

Answer 39

The North American Free Trade Agreement (NAFTA) is a trade bloc made up of the USA, Canada and Mexico. NAFTA supports free trade between its three members. Removing internal quotas and tariffs is the aim of the organisation. NAFTA does not have common external tariffs on nations outside the 'customs union' or 'trade bloc'.

Answer 40

Mercosur is an economic grouping of Argentina, Brazil, Paraguay and Uruguay. It was established by the Treaty of Asuncion in 1991. Mercosur does have an external tariff on goods from outside the trade bloc.

Answer 41

The European Union is a trade bloc made up of 28 European nations (as of 2018). The European Union is the most tightly integrated trade bloc, because it combines common external tariffs, with the free movement of labour and for many nations, a common currency in the Euro.

Answer 42

The Association of Southeast Asian Nations is a trade bloc of 10 Asian countries, including Indonesia, Malaysia, Singapore, the Philippines, Thailand, Brunei, Cambodia, Laos, Myanmar and Vietnam.

Answer 43

European Union (EU) The North American Free Trade Agreement (NAFTA) The Association of Southeast Asian Nations (ASEAN) COMESA (19 countries in east and southern Africa) Mercosur (Argentina, Brazil, Paraguay and Uruguay)

Answer 44

A customs union is a group of countries who agree to remove barriers to trade between the union and enforce common trade barriers to those outside of the union.

Answer 45

A customs union is a step up on a free trade area, the key difference being that in a free trade area there are no common external tariffs.

Answer 46

There are usually no tariffs or quotas between members of a custom union. There is usually a common tariff on goods coming from countries outside of the customs union. Quality regulations are usually standardised within a customs union and people outside the union have to meet these regulations

Answer 47

a modern customs union Southern African Customs Union (which includes Namibia, Botswana and South Africa).

Answer 48

A customs union where all internal borders and between country restrictions have been removed.

Answer 49

The European Single Market has all the features of a customs union in addition to a number of other features: Free movement in goods and services. In almost every case, goods sold in one country are available to all other countries. Free movement of people. People are able to live and work in different countries in the single market. Free movement of money between member countries. Agreed standards and regulations for all goods and services produced in the single market. Members agree not to set rules or make laws that favour their own domestic firms, products or workers over other countries in the market.

Answer 50

European Union membership implies membership of the European Single Market and so all the features the market entails. In particular the freedom of movement of goods, services, people and money. Members also agree to the rules of the customs union including the common external tariffs. Members must accept laws and rulings from EU institutions including the European Court and Parliament

Answer 51

Firstly, the free movement of people – which many believed had led to increased immigration into the UK, higher unemployment and higher costs for the government in supporting immigrants through benefits and government run services including schools. Secondly, autonomy over laws – a number of Brits argued in favour of Brexit as it would mean that the UK would no longer have to accept the laws and rulings of the EU parliament and court. But lots of NHS workers come from the EU and lots of the goods (like BMW cars) that we purchase are bought tariff-free from EU countries

Answer 52

To try and negotiate a reduction in trade barriers Lower trade barriers can help to encourage specialisation and increase global output

Answer 53

Many countries came together to form the General Agreement on Tariffs and Trade (GATT) in 1947. Since 1947, the negotiations have happened in rounds. Countries will negotiate one agreement, then come back some time later and negotiate another agreement.

Answer 54

The role of the WTO is still to encourage free trade, to provide a forum to resolve trade disputes, to lower tariff barriers. The Most Favoured Nation Principle (MFN) says that any tariff reduction offered to one country must be offered to all (against trade discrimination). The WTO Began with 23 members, and now has 163 members. But the WTO is under threat from, in particular, the US' more protectionist stance.

Answer 55

Dumping Some LDCs may fall victim to dumping. This is where more developed countries sell products below cost onto LDC markets. Over half of the anti-dumping cases brought to World Trade Organisation (WTO) are from LDCs complaining about more-developed countries (MDCs). Brain drain Brain drain describes the phenomenon of skilled workers moving abroad to earn higher wages. It is a particular problem for LDCs. Higher wage countries can employ talent from LDC labour markets. This could harm the prospects for economic growth in the LDC. Working conditions Multinational corporations have been criticised for the reported mistreatment of workers in LDCs. Different LDCs may compete for MNC's investment and for having lower health and safety standards for workers, or lower corporate tax rates. For example, Primark paid over $10m to victims of a factory collapse in Bangladesh, which killed over 100 people.

Answer 56

The rise of the USA Stephen Kinzer claims that in 1900, US factories were producing more goods than the whole of the USA could consume. Europe had to protect its economy using high tariffs to respond to this. So in 1900, the USA was overproducing and 'dumping' goods on other markets at a very low cost. This is very similar to what the USA has accused China of since 2010.

Answer 57

a common currency shared with one or more nations

Answer 58

They have a fixed exchange rate

Answer 59

A merged currency provides exchange rate certainty. There is no foreign exchange risk between the countries in the merged currency and this certainty can help to encourage trade

Answer 60

Can’t use monetary policies A disadvantage of a merged currency is that each nation loses the ability to use monetary policy to change their economic outlook. E.g France cannot lower interest rates to increase aggregate demand (AD) and stimulate demand in expansionary monetary policy because the European Central Bank controls the Euro interest rate Each country needs different interest rates European Central Bank (ECB) determines monetary policy for the euro and has representatives from all nations. But the ECB's decision on rates will not always line up with what is best for the economy of an individual country within it. Greece may have high inflation and need higher interest rates and France may have low inflation and need lower interest rates, but the ECB cannot do both. Political risk Fixing a currency at a 'low' rate to make sure that exports are competitive could cause conflict with trade partners who find themselves to be uncompetitive. The US is currently trying to address it's perceived trade imbalance with China, caused in part by the Yuan being kept weak by China buying US dollars. Although the US and China aren't in a merged currency, this could happen between countries in Europe.

Answer 61

A currency union involves two or more countries sharing the same currency. A prominent example of this is the Eurozone (within the EU)

Answer 62

Increased investment in other nations Lower transaction costs Encourages fiscal responsibility Trade stability

Answer 63

Nations can be more certain about investing in other countries in the currency union because their investments will not be exposed to FX risk.

Answer 64

Transaction costs can often reduce welfare. In a currency union, transaction costs for imports and exports are likely to be lower as there is no need to change currency. Although businesses like TransferWise and Revolut have reduced international transaction costs in some markets.

Answer 65

To join the Eurozone currency union, governments must meet criteria with their fiscal policy. Countries like Greece did not maintain discipline and had very large fiscal deficits after adopting the Euro.

Answer 66

There will be an improvement in the stability of trade between member countries of the union. This is because prices won't be affected by changes (or fluctuations) in the exchange rate.

Answer 67

Different economic make-up Lose monetary policy as a tool Entry costs

Answer 68

If the countries’ economies are too different, then the appropriate value of their currency may be different from that of the union as a whole. This could slow down that country’s growth and harm other objectives. If the Euro is valued too highly, nations like Greece and Portugal may find that their exports are uncompetitive.

Answer 69

The currency union takes control of the monetary policy for the union as a whole. So individual countries lose autonomy. The central bank will choose policies which should benefit the union as a whole but that could reduce a country's ability to respond to shocks in their own economy. If unemployment is 30% in Greece, but 2% in France and Germany, the European Central Bank is unlikely to cut interest rates (use expansionary monetary policy) to reduce unemployment in Greece because it may lead to excess inflation in France and Germany.

Answer 70

There can be initial costs in joining a currency union to prepare firms and households for the change. This may be through tighter monetary or fiscal policy in the build-up to joining.

Answer 71

Protectionism involves protecting a country's domestic industries, companies and jobs from foreign competition. Protectionism could take the form of tariffs, quotas or other barriers to trade

Answer 72

Tariffs Import quotas Non-tariff barriers Subsidies to domestic producers

Answer 73

Tariffs are a tax imposed on a product when it is imported into a country, which increases the price of imports to reduce the competitiveness of the goods (promoting domestic goods and services in the process). Tariffs raise tax revenue for the importing country. These funds could even be used to subsidise domestic firms. Tariffs will probably increase the price of goods faced by domestic consumers.

Answer 74

Quotas restrict the actual quantity of good imported. They can be a 'cap' on the number of goods which can be imported, reducing foreign supply. Quotas allow governments to have exact control over the quantity of goods imported but don't raise any tax revenue. Quotas will probably increase the price of goods faced by domestic consumers.

Answer 75

Non-tariff barriers to trade can include import bans, rules of origin (e.g. having to prove a product did not come from a conflict zone), quality conditions imposed by the importing country on the exporting countries etc. Exchange rate manipulation: A government / central bank may intervene in the foreign exchange market to lower the value of its currency by selling its currency in the foreign exchange market. This will give its exports a price advantage abroad.

Answer 76

Governments can give subsidies to domestic producers to help them to compete against other providers internationally. The EU limits the subsidies that nations are allowed to implement under 'EU State Aid' rules. A subsidy would reduce a firms' costs and make them more price competitive internationally.

Answer 77

Anti-dumping laws Protect domestic jobs Environmental concerns Protect infant industries Raises tax revenue Reduces trade deficit Reduced dependence on imports

Answer 78

Anti-dumping laws block imports that are sold below the cost of production by imposing tariffs that increase the price of these imports to reflect their cost of production. Dumping can be used to drive firms out the market.

Answer 79

Protectionism can protect jobs, particularly those in jobs with low wages. Protectionism may help domestic companies to make higher profits, which could be passed on to workers with positive multiplier effects.

Answer 80

The consequences of globalisation for the environment are not good. Economic activity more generally can pose environmental dangers. Large multinational corporations often shift their production to lower income countries to take advantage of lower environmental protection standards.

Answer 81

Infant industries are new industries that are developing. Blocking imports for a limited time has historically helped countries' own industries to develop. It has helped them in the long-run by allowing them to first achieve economies of scale and become competitive.

Answer 82

Protectionism raises government revenue from tariffs. This is especially relevant for LDCs who may have a weak tax base otherwise.

Answer 83

Because protectionism will involve lowering imports (M), it will lower a trade deficit, which boosts aggregate demand (AD). This is assuming there is no retaliation.

Answer 84

Protectionism could help to rebalance an economy from imports to domestic consumption – which will increase domestic employment.

Answer 85

X-inefficiency Risk of retaliation Higher input costs Higher prices and less choice

Answer 86

Protectionism could lead to long term dependency on protection. This is because protectionism breeds inefficiencies because firms are protected from foreign competition. E.g. 60% of EU budget is spent on subsidising agriculture through the Common Agricultural Policy, although agriculture is worth less than 15% of EU GDP.

Answer 87

Countries often retaliate against tariffs and this can reduce a country's exports. Exports are a component of aggregate demand (AD), so AD could fall.

Answer 88

If the protected product is an input, it will raise the costs of production of the industry that uses the input. This makes domestic firms less competitive if they are hoping to export. This could also give rise to cost-push inflation.

Answer 89

Domestic consumers may have to pay more for goods in the protected industry. They have less to spend in other industries, which could lead to job losses. So these low-wage workers pay higher prices for basic necessities and, as such, their money can buy fewer goods. In the US, textile and apparel protectionism adds to the costs of imports. So consumers end up paying billions of dollars more for clothing each year. Consumers also have less choice over what to consume.

Answer 90

A well-known example of protectionism was the ‘banana wars’ of the early 2000s. The EU had a trade deal with the Caribbean which set a quota of how many bananas each country could sell to Europe. The idea was that this would help these countries to develop without needing aid. But this was an act of protectionism because it stopped the free trade of bananas and made bananas from outside of the Caribbean look more expensive. The US complained to the World Trade Organisation that this was limiting global trade and stopping their bananas from selling in Europe.

Answer 91

Infant industries are industries that are in the early stages of development in the domestic country. Adding tariffs to foreign goods can help infant industries create domestic jobs and let an industry develop. The USA did this with lots of iron and steel industries in the late 1800s.

Answer 92

Countries often retaliate against tariffs and this can reduce a country's own exports. In 2018, China proposed a 25% tariff on US liquefied natural gas in response to Donald Trump's proposed tariffs

Answer 93

The balance of payments shows a record of all transactions that a country does with the rest of the world.

Answer 94

current account capital account financial account

Answer 95

Trade in goods and services (X-M). Net primary income - net factor income from abroad (e.g. remittances, profits, interest on dividends). Net secondary income - net unilateral transfers (e.g. foreign aid).

Answer 96

Sale/transfer of patents, copyrights, franchises, leases and other transferable contracts, and goodwill. Transfers of ownership of fixed assets.

Answer 97

Net foreign ownership of domestic assets. Hot money flows.

Answer 98

The balance of payments has to add up to 0. But in reality, there are errors and omissions in calculating what comes in and what goes out of an economy. So we add a “balancing item” or “net errors and omissions” to make it balance.

Answer 99

Value of exports - value of imports

Answer 100

Services trade balance Merchandise trade balance Income receipts and payments Unilateral transfers

Answer 101

This is made up of the exports and imports of services. Barclays selling financial services (e.g investment bank consultancy fees) to a company based in Saudi Arabia would count as the export of services.

Answer 102

The merchandise trade balance is made up of the exports and imports of goods. The sale of Aston Martins made in the UK would count as an export of goods in this section of the balance of payments.

Answer 103

Income receipts and payments includes money received from foreign investments. Investment income can come from investments abroad. When someone invests in the US and makes a return, this is then transferred to the person in the UK who owns the asset.

Answer 104

Unilateral transfers are payments by governments or individuals in which money is sent abroad without any direct good or service being received. The UK sending humanitarian aid to African countries, India or North Korea would count as a unilateral transfer.

Answer 105

Low productivity, meaning the final price of the goods are likely to be higher. Inflation being higher domestically than abroad, reducing the international competitiveness of domestic goods. A strong exchange rate, reducing the price of imports and increasing the price of exports. Non-price factors, such as poor quality of goods and services. Supply-side constraints, which could cause a lot of goods being imported from abroad.

Answer 106

If a deficit is because of capital goods imports, then it is likely to be good for future productivity and future growth. If a deficit is because of the purchase of current goods, it will be good for the short-term standard of living. If it because of a lot of FDI in the past, profits are being repatriated today. This means the investments were profitable. If the deficit is a high % of GDP and is getting worse, this may be worrying. If nobody wants to buy a country's exports, then this may be concerning.

Answer 107

A current account deficit needs to be financed by a financial account surplus - so it will become a problem if foreign investors stop wanting to purchase assets in that country. If a country has a free floating currency, the currency will depreciate. This may partially offset the uncompetitiveness of exports. This will also cause the price of imports to rise though, leading to higher prices for consumers and potentially cost-push inflation.

Answer 108

Depreciation

Answer 109

expenditure-switching expenditure-reducing

Answer 110

Expenditure switching policies aim to influence the relative prices of exports and imports - to switch expenditure away from imports and towards domestic consumption / exports. Expenditure-switching policies could include tariffs, supply side policies and exchange rate manipulation. Supply side policies could be used boost international competitiveness of exports and so improve the current account deficit - either by improving the quality or the price of exports.

Answer 111

Expenditure reducing policies aim to control aggregate demand (AD) and limit spending on imports. Expenditure reducing policies would be contractionary monetary and fiscal policies, which would serve to reduce AD, and so real GDP and incomes. This means the marginal propensity to import and current account deficit will fall. The consequences for the wider economy are that the economy’s real GDP will fall. Fiscal policy, like increasing income taxes, would reduce disposable income and cause unemployment.

Answer 112

By attracting FDI

Answer 113

Shifting the LRAS of an economy outwards. Creates employment. A rise in the stock of capital. Contributes to aggregate demand (AD) and so real GDP (multiplier effects). Regional economic impact, especially in areas of lower employment. Positive effects on productivity. Funds to contribute to growth (especially if domestic credit is lacking). Competition for domestic businesses. Inward investment by foreign manufacturing firms can cause a rise in exports.

Answer 114

Research and development (high-value added) activities remaining in the “home” country. Long-term repatriation of profits. Strategic assets owned by foreign companies. The economy becoming increasingly dependent on external firms. Race to the bottom by governments to attract FDI (e.g. tax and regulations compromised).

Answer 115

The exchange rate refers to how much of a foreign currency one unit of domestic currency will buy you. £1=$1.40 means that £1 of sterling will buy $1.40 of US dollars

Answer 116

With floating exchange rates, the government or central bank let the foreign exchange markets set exchange rates. The value of a floating exchange rate is affected by the supply and demand of the currency in public markets.

Answer 117

Expansionary monetary policy usually lowers interest rates to increase demand in the economy. This affects foreign exchange markets because: The lower interest rates will reduce demand for the currency because returns in that country are lower, leading to a depreciation in the domestic currency. A central bank can also influence FX markets directly. It can increase the supply of its own currency (£) and buy other foreign currencies, again depreciating the domestic currency.

Answer 118

that if government policies were more predictable and stable, then inflation rates and interest rates would be more predictable and stable. But floating exchange rates have been more volatile than economists expected them to be in the 1970s.

Answer 119

Strong. Pound. Imports. Cheaper. Exports. Dearer.

Answer 120

70/1.40 = 50 £50

Answer 121

Less need to hold reserves Freedom to use monetary policy for other aims Stabilise balance of trade

Answer 122

With floating rates, there is no obvious need for a central bank to hold foreign exchange reserves. This is because a key reason to hold them is to intervene in the currency market. With a fixed exchange rate, the Central Bank needs to hold reserves and is vulnerable to speculation.

Answer 123

It is not possible for a country to have fixed exchange rates, perfect capital mobility and independent monetary policy. This is called the monetary trilemma. Sacrificing control over exchange rates allows capital (funds) to flow freely into a country, which encourages investment, and also for the central bank to have control over the interest rate, allowing them to better manage inflation.

Answer 124

A free floating currency allows for an automatic adjustment mechanism. E.g. if there is a current account deficit, this will lead to outflow of currency, causing a depreciation of the currency. This depreciation will lead to a greater competitiveness of exports. This will help to improve the current account and partially correct the problem. When demand for exports rise, the value of the currency will rise making exports more expensive and when demand for exports falls, the value of the currency will fall making exports cheaper.

Answer 125

Potential speculation Cost-push inflation from depreciation Increased uncertainty

Answer 126

A freely traded currency can still be vulnerable to speculation as investors try to make investment returns by trading FX. Higher levels of speculation could in turn increase volatility.

Answer 127

If a currency depreciates, the price of imports rises. This could lead to imported raw material costs rising, leading to cost-push inflation. Less macroeconomic discipline is needed by a government - if the domestic inflation is higher than foreign inflation rates, the currency will depreciate. This will reduce the difference the impact the inflation is having.

Answer 128

Increased uncertainty over the exchange rate could mean that long term international investment is discouraged because potential investors will be of unsure of future prices. This hampers business confidence, which in turn deters investment and could give rise to a negative multiplier.

Answer 129

Currency depreciates Import price of goods and services increases Firms who import materials and components face increased costs Costs of production increase SRAS is decreased (shifts left) Price level rises

Answer 130

In a fixed exchange rate system, the government or central bank chooses a value that it wants the currency to be stable at

Answer 131

In a fixed exchange rate system, the government or central bank chooses a value that it wants the currency to be stable at. There are two ways to do this: A soft peg A hard peg

Answer 132

A soft peg is where the government usually allows the exchange rate to be set by the market, but in in some cases, the central bank will intervene with the market. The central bank could increase the supply of the domestic currency (£) or buy other currencies. The Chinese yuan is softly pegged to the US dollar. The Swiss franc was softly pegged to the Euro until 2015, when it abandoned the peg.

Answer 133

With a hard peg policy, the central bank sets a fixed and unchanging value for the exchange rate. The central bank will have to buy and sell currency using its currency reserves to keep the fixed exchange rate at the value of the hard peg. Hong Kong uses a currency board to keep a hard peg to the US dollar. The Hong Kong Monetary Authority fixes its exchange rate to the USD at HKD7.8.

Answer 134

Brings stability for firms and households Encourage government responsibility

Answer 135

Stability in the exchange rate can encourage firms to invest and households to spend because of the confidence/certainty it builds. Transactions that involve world trade will rise in particular.

Answer 136

There is no correction of current account deficits, and so a fixed rate forces a government to act more responsibly. Governments will be forced to use supply-side and fiscal policy to control the factors that lead to pressure on the exchange rate (e.g high inflation). This may be positive or negative if controlling inflation leads to high unemployment.

Answer 137

An increase in world trade

Answer 138

Lose power over monetary policy Speculative pressure Unstable current account

Answer 139

If a central bank uses monetary policy (interest rates) to alter the exchange rate, then it cannot use monetary policy to address issues of inflation or recession at the same time. For example, a government may want to depreciate the currency to make exports more competitive by reducing the interest rate, but this would have the side-effect of potentially increasing inflation through increased consumer spending (C) and investment (I), as well as higher import prices.

Answer 140

Holding large reserves of a currency and intervening in the foreign exchange market has a severe opportunity cost. A hard peg policy will not allow fluctuations. But speculators may try to force a country to leave its peg if they sense an incorrect value. This happened on 'Black Wednesday' in 1992 when the UK was forced to abandon its peg to the currency of Germany. This cost the UK government billions of pounds in the process of artificially boosting the Pound by spending foreign reserves.

Answer 141

Unlike with floating exchange rates, the current account balance isn't corrected by the natural mechanism of changing the relative price of imports and exports. If there are lots of imports or exports, the 'price' of the currency does not change. This means fixed exchange rates fail to adjust for changes in competitiveness over time.

Answer 142

Large opportunity costs of holding foreign currency reserves

Answer 143

To try to keep the pound above £1=2.7 marks (and appreciate the currency), the Bank of England raised interest rates. Speculators short sterling People like George Soros thought that high interest rates would damage economic growth and thought that the Bank of England could not buy enough sterling to keep to the exchange rate peg The Bank of England was losing billions trying to support the exchange rate. Instead, they stopped trying to keep the peg. Currency pegs can be attacked. In September 1992 (on Black Wednesday), the UK had to leave the European Exchange Rate Mechanism. Britain tried to keep its exchange rate above £1=2.7 German marks

Answer 144

A depreciation is when a currency's value falls in a floating exchange rate regime. A devaluation is when a currency's value falls in a fixed exchange rate regime.

Answer 145

A competitive devaluation would see a government or central bank reduce the value of their currency by adjusting the currency peg. A common hope is that by reducing the value of the currency, that nation's exports will become more price competitive and attractive to consumers in other nations. Because exports are a component of GDP, a rise in exports could increase economic (or GDP) growth. The nations leaving the Gold Standard in the 1930s after the Great Depression benefited from 'beggar thy neighbour' devaluations, as they reduced the value of their currency relative to those on the Gold Standard, benefiting from a rise in exports.

Answer 146

A competitive depreciation would be a similar move to a competitive devaluation, but this happens in the free FX market. It could be argued that Britain's exit from the EU, which saw sterling fall by 15% versus other currencies between June 2016-18 was a competitive depreciation. However, this was more accidental.

Answer 147

After a competitive depreciation or devaluation, the value of a currency falls. Imports become more expensive and exports become more price competitive overseas. However, in the instant of the change, nations cannot change their consumption patterns (because of things like 30-day or 90-day contracts). In the short term the current account deficit will reduce as exports become cheaper and imports become more expensive.

Answer 148

The Marshall-Lerner condition states that a nation's balance of payments current account balance will only improve after a depreciation or devaluation if PEDexports + PEDimports >1. This improvement will come in the long run, but the J curve shows that in the short term, the situation will still get worse. Even if PEDexports + PEDimports >1, the current account will still get worse in the short run. Demand tomorrow is more inelastic than demand in 1 year because people cannot switch to substitute goods because of things like contracts. The J-curve shows things getting worse before they get better.

Answer 149

Even if PEDexports + PEDimports >1, the current account will still get worse in the short run. Demand tomorrow is more inelastic than demand in 1 year because people cannot switch to substitute goods because of things like contracts. The J-curve shows things getting worse before they get better.

Answer 150

productivity and the relative cost of goods and services produced in a nation

Answer 151

Relative unit labour cost is the average cost of labour per unit of output in one country divided by the average cost of labour per unit of output in another country. Relative export prices is the prices of exports from one nation relative to the prices of exports of another nation. This is usually calculated in an index.

Answer 152

Wage costs affect competitiveness. The higher wages are, the less competitive a nation is ceteris paribus. High inflation will reduce competitiveness because prices are rising. Higher labour productivity increases competitiveness because workers are producing more using the same inputs or in the same amount of time. Real exchange rates (nominal exchange rate X (price level in UK/price level abroad) help to determine relative export prices. The real exchange rate takes price/inflation into account. Any other costs incurred by firms, such as legal or admin costs can decrease competitiveness. R&D and Technology can increase productivity and competitiveness, so government policies encouraging or subsidising this may be good.

Answer 153

Being internationally competitive can lead to a current account surplus in the balance of payments. A current account surplus shows that (X-M), which is part of GDP is positive. A growing current account surplus can drive economic growth. Increasing economic growth and exports can create employment in a nation. Being internationally competitive can allow a firm to export internationally and benefit from economies of scale by increasing output to a higher level.

Answer 154

If a nation becomes more uncompetitive, imports become more expensive domestically. If a nation relies on imports then it can lead to increased cost-push inflation. If the (X-M) component of GDP decreases then GDP shrinks. Slower or declining GDP growth can lead to unemployment in a nation. Being uncompetitive may mean that businesses can only sell to their domestic market. This may stop them from benefiting from economies of scale. Businesses that are internationally competitive and have economies of scale can be big national employers e.g. Nokia in Finland.

Answer 155

Policies that lower firms' wage costs, other costs or increase productivity can all boost competitiveness. Removing a minimum wage may lower labour costs, but it may cause a rise in inequality and poverty. Reducing legal and admin costs to businesses (and removing red tape) could make businesses more competitive, but it could reduce workers' health and safety. etc. A devaluation could make a nation's exports more attractive as the real (and nominal) exchange rate would fall. Subsidies for R&D could lead to technological advances that raise labour productivity. Subsidising production could lower businesses' costs but many subsidies are banned by organisations like the EU. Creating a flexible labour market, with easy hiring and firing could reduce employment costs for businesses.

Answer 156

Real exchange rates = (nominal exchange rate X (price level in UK/price level abroad) They help to determine relative export prices. The real exchange rate takes price/inflation into account.

Answer 157

Explain protectionism Protectionism involves protecting a country's domestic industries, companies and jobs from foreign competition. Protectionism could take the form of tariffs, which are taxes on imports, quotas or other barriers to trade. The US since 2016 has pulled out from many multilateral trade deals and imposed new tariffs. Arguments for protectionism Protectionism can protect domestic jobs from international competition. The 'rust-belt' states of the US suffered from structural unemployment issues due to the decline of the domestic industry. The infant industry argument can also be made: trade barriers are necessary for a country to build up its own industries and enable them to achieve economies of scale before opening them up to global competition. Further arguments for protectionism Trump has cited US trade deficits with China and Germany as issues of national concern. Protectionism can help lower imports and correct these imbalances. There is an argument that trade barriers are necessary when foreign countries deliberately manipulate their exchange rates to undercut others. Trump has made this case against China in particular.

Topic 7 - A Global Perspective Flashcards

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