Transcript 4.1.8 Exchange rates studentx

Students should be able to:
 Define exchange rate systems (floating; fixed and
managed)
 Distinguish between revaluation & appreciation and
between devaluation & depreciation of a currency
 Analyse factors influencing floating exchange rates
 Analyse government intervention in currency markets
through foreign exchange transactions and the use of
interest rates
 Evaluate competitive devaluation/depreciation and its
consequences
 Evaluate the impact of changes in exchange rates (the
current account of the balance of payments (MarshallLerner condition and J curve effect); economic growth
and employment/unemployment; rate of inflation; FDI
flows)
Exchange rates are ________________________
__________________________________________
• Floating exchange rates means that _________
and supply determine the rate at which one
currency exchanges for another. E.g.
• Fixed exchange rates are where a country’s
exchange rate is fixed in relation to, say the US $
• Fixed exchange rates can only be changed by the
central bank in agreement with other countries
usually mediated through the IMF.
• E.g. Danish Krona fixed to the _______
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Managed exchange rates imply that the monetary
authorities control the exchange rate through the
buying and selling of the country’s currency on the
foreign exchange market and through changes in
____________ rates.
Day-to-day the market sets the rate but
occasionally the Central Bank may intervene e.g.
Switzerland (______) or Japan (_____)
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Appreciation and depreciation are the terms
used under a system with _________ exchange
rates to describe increases and decreases in the
value of a country’s currency in relation to other
currencies.
Revaluation and devaluation are the terms used
under a system with _________ exchange rates to
describe increases and decreases in the value of
a country’s currency in relation to other currencies
determined by the country’s central bank.
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Appreciation/revaluation means that the value of
the pound, in terms of other currencies, has
___________
For example, if the value changes from £1 = $1.50
to £1 = $1.70 then the £ has become stronger and
_______ dollars are required to buy £1.
With an appreciation/revaluation, even though a
good may still be priced at £10, it now costs
Americans $___ instead of $___, therefore
___________ demand for UK exports.
Remember SPICED!
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Depreciation/devaluation means that the value of
the pound, in terms of other currencies, has
_____________
For example, if the value changes from £1 = $1.50
to £1 = $1.40 then _____ pounds are required to
buy $1.
With a depreciation/devaluation, even though a
good may still be priced at £10, it now costs
Americans only $___ instead of $___, therefore
______________ demand for UK exports.
The exchange rate will be determined by the supply
of, and demand for, the currency which depends on:
• If UK interest rates rise (relative to other countries)
then demand for £ increases (currency appreciates)
• Purchasing power parity theory of exchange rates
states that exchange rates in the long-term change
in line with inflation rates between economies.
Define the term purchasing power parities (2 marks)
Demand or supply?
The current account: UK exports create a ________
for sterling whereas imports into the UK create a
_______ of sterling on the foreign exchange market;
therefore, an increasing trade surplus would cause
an increase in the value of sterling
Net investment into the UK: FDI into the UK creates
a ________ for sterling whereas UK investment
abroad creates a _________ of sterling; therefore,
an increase in FDI from abroad would cause the
value of sterling to rise
Demand or supply?
• quantitative easing – since QE has the effect of
increasing money ___________, it is likely that this
will cause a depreciation in the country’s exchange
rate.
• state of the economy - e.g. slow down in the
economy is likely to cause a fall in confidence and a
decrease in FDI and less ____________ for the
currency hence value of the currency will fall
• changing interest rates – if the central bank
wishes to increase the value of the country’s
currency, it would _________ interest rates, so
making it more attractive for foreigners to place cash
balances in the country’s banks
• intervention on the foreign exchange market –
if the central bank wishes to increase the value of
the country’s currency then it would buy its own
currency. (This is called “foreign currency
transactions” under “Government intervention in
currency markets” on your syllabus)
• Hot money is money that is moved by its owner
__________ from one form of investment to
another.
The aim is to take ________________ of changing
international _______________ rates or to gain
______________ short-term returns on
investments.
advantage exchange high quickly
• Some countries try to gain competitive advantage
by taking measures to ___________ the value of
their currencies.
However, if several countries do this then any
advantage would disappear quickly. Consequently,
there might be a decline in world trade if countries
pursued such a policy – as happened in the 1930s.
(This is called “competitive devaluation/depreciation
and its consequences” on your syllabus)
An appreciation/revaluation of a country’s currency
would have the reverse of the above effects.
• A depreciation or devaluation will __________ the
competitiveness of a country’s goods and services
by causing a fall in the foreign currency price of its
exports and an ___________ in the domestic price
of its imports.
However, there will only be an improvement in the
current account of the balance of payments if the
sum of the PEDs for exports and imports is greater
than 1.
This is called the Marshall-Lerner condition.
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But, the impact on the current account may be
different in the ____________run than in the long
run.
In the short run there might be a ____________
in the ______________ account of the balance of
payments because the demand for imports might
be price ______________ if firms have stocks or
if they are tied into contracts; and the demand for
exports might be price ____________ because
consumers take time to adjust to the new, lower,
prices.
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But, in the long run demand for exports and
imports is likely to become ___________ price
elastic so the significance of the above factors
disappears.
This difference in short-run and long-run effects
is often referred to as the J curve effect.
• Economic growth and employment/unemployment:
an increase in the competitiveness of a country’s
goods and services following a depreciation (or
devaluation) should result in a _________ in
unemployment as demand for the country’s goods
and services ______________
• Rate of inflation: the price of imported raw
materials and manufactured goods will __________
following a depreciation/devaluation.
This could have inflationary consequences, why?
But its impact on individual producers depends on
their reliance on imports and/or exports
• FDI flows: following a depreciation/devaluation it
would be cheaper for global companies to invest in
the country so FDI might _____________
• Assess the possible effects of the fall in the
external value of the rupee on the Indian economy
(12).
(remember the syllabus “Impact of changes in
exchange rates”…)