Flashcards in Unit 4: Chapter 3 - Exchange rates and the balance of payments Deck (102)
What do exchange rates express?
The value of one currency against another
What is the interaction between different currencies?
A derived demand
What is the effect of a fall in the value of the pound against the dollar?
The price of British goods becomes cheaper because Americans have to sacrifice fewer dollars to purchase the same amount of British goods
What does a fall in the exchange rate lead to?
Demand for a currency increasing as there is a movement along the demand curve
What is Sterling's average rate measured by?
The Sterling Trade Weighted Index - it is weighted to reflect the relative importance of different countries in terms of UK trade
Why does the Sterling Trade Weighted Index get criticised?
The weights get adjusted too infrequently and changes to the pattern of UK trade take too long to be included in revised weightings
What was the effect of the criticisms of the Sterling Weighted Trade Index?
It led to a new version of the index which an adjust more rapidly to changes in trade patterns
Where does the equilibrium exchange rate occur?
Where the demand of pounds = supply of pounds i.e. where the demand and supply curves intersect
What is the role of the foreign exchange markets?
If there is a shortage or surplus of pounds, then the role of the foreign exchange markets would be to equate the demand for pounds with the supply for pounds
What do pounds go through when they need to be transferred to another country?
The foreign exchange
When do the demand and supply curves for a foreign currency shift?
If a factor other than price changes
How does inflation cause a change in the exchange rate?
A rise in UK inflation relative to other countries would make UK goods less competitive and this would shift the demand curve for pounds inwards
How do interest rates cause a change in the exchange rate?
A rise in UK interest rates will shift the demand curve for pounds outward because UK financial assets would become more attractive i.e. hot money
How do incomes cause a change in the exchange rate?
A rise in incomes in other countries would increase demand for UK exports and this would shift the demand curve for pounds to the right
How does GDP cause a change in the exchange rate?
An increase in GDP in other countries would cause demand to shift out
How do tastes cause a change in the exchange rate?
If it was perceived that foreign goods were of higher quality than British goods then this would shift the supply curve of pounds to the right
How does speculation cause a change in the exchange rate?
Fluctuations are caused by speculation which is people trying to earn a profit by buying and selling currencies by predicting which way market forces will move
What is the acronym which shows the impact of a change in value of a currency on exports and imports?
SPICED - strong pound imports cheap exports dear
What is a depreciation?
When the exchange rate falls - the value of one currency is lowered against others
What is an appreciation?
When the exchange rate rises
What should be the fundamental determinant of exchange rates and what interferes with this?
The fundamental determinant should be the demand for a country's exports but domestic interest rates also have an impact
What is the effect of the exchange rate depreciating?
This will lead to a fall in export prices and this should result in an increase in demand for exports, the extent to which this is the case will depend upon the foreigners' price elasticity of demand for British goods, the price of imports will also rise and thus have a positive effect on growth as AD = C + I + G + (X - M)
What can the exchange rate be affected by?
Policy decisions which are made outside the UK
What should growth due to the exchange rate depreciating lead to?
A reduction in unemployment however this assumes that there are no capacity constraints or skills shortages in the export sector
What will a rise in the prices of imports lead to?
A rise in inflation because some of the goods in the RPI will be imported, the extent to which this is the case will depend upon the share of imports in the representative consumer's basket of goods
What is a floating exchange rate?
Allows the exchange rate to move freely according to changes in demand and supply for the currency - there is no government intervention to help meet other policy objectives
What are managed floating exchange rates?
It is a floating exchange rate in the foreign exchange rates markets but it is subject to intervention from time to time by the monetary authorities
Why might monetary authorities intervene in the exchange rate?
A central bank may try to depreciate the exchange rate in order to improve the balance of trade in goods and services, reduce the risk of a deflationary recession or to rebalance the economy away from domestic consumption towards exports and investment
What is the exchange rate mechanism?
It has an allowed range for the exchange rate to be in - if it moves beyond this range the government would be obliged to act i.e. they could buy up a currency or raise interest rates by shifting demand to the right