| What is a Fixed Exchange Rate? | -This is where the Government or Central Bank sets the Exchange Rate. This requires Maintaining the Exchange Rate at a Target Rate |
| What is a Floating Exchange Rate? | -Currency is free to move with Changing Supply of, and demand for, a Currency. No Policy from Government of Central Bank |
| What is a Hybrid Exchange Rate? What are the different Systems? | -Hybrid Exchange Rate is a Mixture of Fixed and Floating
-Managed Floating is where the Exchange is Largely left to Market Forces, but the Government sometimes will Intervene to Influence the Exchange Rate when Needed
-Semi-Fixed is where the Exchange Rate can Fluctuate within a Set Band of Exchange Rates
-Pegged is where the Value of the Currency is Attached to another Currency. Can be moved Periodically or however the Government think its right |
| How will a Fixed Exchange Rate maintain it at the Target Rate? | -The Government or Central Bank will Control the Interest Rates + Buy and Sell the Currency using Foreign Currency Reserves to keep the Supply of, and Demand for, the Currency the Stable |
| What is a Nominal Exchange Rate? What about a Real Exchange Rate? | -An Unadjusted or Direct Comparison of Values of Currencies
-But a Real Rate is a Nominal Rate that is Adjusted to take Price Levels into Account |
| Why is there a Need for Real Exchange Rate? | -Nominal Exchange Rates will not always Reflect the True Worth of Currencies
-The Real Exchange Rate will Overcome this by Factoring the Prices in Different Nations into Account |
| What is a Bilateral Exchange Rate? | -The Comparison of just 2 Currencies. For example, a Nominal Bilateral Exchange rate can Directly Compare the US Dollar with the UK Pound, and show £1 : $1.50 |
| What is an Effective Exchange Rate? | -A nation's Currency is Compared to a Basket of Currencies (usually its Trading Partners) and is a Weighted Average. The Proportion of the nation's Trade with each partner determines its Weighting. This gives an Overall Summary of the Value of a Currency compared to Several Others. |
| How can the
1. Devaluation
2. Revaluation
Occur when it's a Fixed Exchange Rate? | 1. Devaluation occurs when the Exchange Rate is Lowered, usually by the Government. They do this by selling the Currency
2. When Government wants the Exchange Rate to go up, the Government will Buy the Currency |
| What is a Depreciation and Appreciation of an Exchange Rate? | -Depreciation of a Floating Exchange Rate refers to when the Exchange Rate falls, perhaps due to Marlklet Forces or Indirect Government Actions
-Appreciation of a Floating Exchange Rate refers to when the Exchange Rate Increases, again because of the same reasons. |
| What is Competitive Devaluation and Competitive Depreciation? | -Competitive Devaluation can be seen in Fixed or Hybrid Systems. The Government Forcefully Devalues their Currency to Improve International Competitiveness.
-Competitive Depreciation occurs in Floating or Hybrid Exchange Rates, and its where Government Intervention Indirectly Reduces the Value of their Currency. |
| What is the Difference between Devaluation and Depreciation? | -Devaluation refers to a Deliberate Downward Adjustment of a Currency's Fixed Exchange Rate by Governments or Monetary Authorities
-Depreciation refers to a Market-Driven Decrease, or Indirect Government Action, of the value of a Currency in a Floating Exchange Rate |
| What are the Advantages of a Floating Exchange Rate? | -Fixed Exchange Rates require Central Banks to have Foreign Currency Reserves to Maintain the Exchange Rate. A Floating does not need such a Requirement
-Floating Exchange Rate can Reduce the BOP Current Account Deficit. A BOP Deficit will lead to the Fall Value of the Currency so if Demands for Exports and Imports are Price Elastic, Exports will Increase and Imports will Decrease which Reduces the BOP Deficit
-Floating Exchange Rate means Governments don't have to use Monetary Policy to help Maintain the Exchange Rate. Can be used for Other Objectives |
| What are the Disadvantages of a Floating Exchange Rate? | -Floating Exchange Rate can Fluctuate Widely, making Business Planning Hard
-Speculation can Artificially Strengthen an Exchange Rate, making the Nation lose competitiveness. Can also be the other way around (Weaken the Exchange Rate and make Imports Expensive)
-Falls in Exchange Rates lead to Inflationary Pressures, for example, if Demand for Imports are Price Inelastic |
| What are the Advantages of a Fixed Exchange Rate? | -Speculation is Reduced unless there are Fears of a possible Revaluation or Devaluation
-Competitive Pressures placed on Firms. They must keep Costs Down, Invest, and Boost Productivity to Be Competitive. Can not Rely on Devaluations
-Fixed Exchange Rate brings Stability which can Encourage Investment |
| What are the Disadvantages of a Fixed Exchange Rate? | -If the Fixed Exchange Rate is no longer suitable, they may start Speculating, Sell the Currency, and make the situation Less Suitable
-Nation loses Control of Interest Rates, as they need to be Used to keep the Rate at the Desired Level
-Can be Difficult and Expensive to Maintain |
| How are Floating Exchange Rates determines by? | -Changes in Supply and Demand for a Currency. Market Forces! |
| How can Supply and Demand Fluctuations be caused by? | -Speculation: People buy and sell currencies based on Changes they Expect are going to Happen
-Official Buying and Selling of Currency by Government or Central Bank
-Relative Inflation Rates. If Inflation is Higher than Competitors then the Value of its Currency will Fall making Prices less Competitive. Exports will Fall and Imports will rise leading to Less Demand for the Currency and more Supply
-Relative Interest Rates. High Rates Increases Demand for Currency due to Hot Money inflows
-Confidence in the State of the Economy If People are Worried, then they may not hold Currencies in that Economy
-Trade Flows. If a Nation has a High Exports than Imports, then Demand for the Currency will be Higher, leading to an Appreciation |
| What happens when the Value of a Currency falls in terms of the Economy? | -Exports become Cheaper, and so Domestic Goods become Competitive. This leads to Greater Demand
-Imports become more expensive and so Demand for Imports fall
-Currency Account deficit should be reduced, and a Surplus should Increased
-Employment and Economic Growth are both Increased
-Inflation can rise if Demand for Imports are Price Inelastic, which can lead to Cost Push Inflation |
| When Exports become more Expensive and Imports becomes more Cheaper, due to an Appreciation of a Nations Currency, what happens to the Economy? | -Increase in Size of the Current Account Deficit / Reduced Current Account Surplus
-Fall in AD which may lead to Fall in output
-Unemployment may Rise as a result
-Impact on Inflation depends on Price Elasticity of Demand for Imports and for Domestic Goods |
| What is the Marshall-Lerner Condition? | -Fall in Value of Currency will only Reduce a Current Account Deficit if the Marshall Lerner Condition Holds
-This states that for a Fall in Value of Currency to lead to Improvement in Balance of Payments, the Price Elasticity of Demand for Imports + Price Elasticity of Demand for Exports must be Greater than 1
PED (for Imports) + PED (for Exports) > 1 |
| What does the J Curve show? | -The Marshall Lerner Condition may work in the Long Run - the Current Account will improve if the Value Falls
-But in the Short Run, the Current Account Deficit will probably Worsen, as it takes time for such changes to the Value to precipitate into the Economy - Contracts for example
-The Overall Value of Exports falls, and the Value of Imports rises, so the CA Deficit Worsens. |
