Exchange Rates

• What is a bilateral exchange rate?

  The value of one currency in another
• What does an effective exchange rate describe?

  The strength of one currency to a basket
• How is an exchange rate defined?

  The purchasing power of a currency
• What is a fixed exchange rate?

  The currency value is set against another
• How is a floating exchange rate determined?

  By market demand and supply of the currency
• What is a hybrid exchange rate system?

  A mix of fixed and floating exchange rates
• What are nominal exchange rates?

  The weight of one currency relative to another
• What are real exchange rates?

  Exchange rates adjusted for inflation
• What does a trade-weighted exchange rate measure?

  Changes against a basket of currencies
• What happens in a floating exchange rate system when demand increases?

  • Market equilibrium shifts to a higher price
  • Exchange rate appreciates as demand rises
• How does a fixed exchange rate system operate?

  • Central bank manipulates currency supply
  • Currency value is maintained at a set rate
• What is depreciation in currency terms?

  When a currency's value falls relative to another
• What is appreciation in currency terms?

  When a currency's value increases
• What is devaluation?

  Official lowering of a currency's value
• What is revaluation?

  Adjustment of currency's value relative to a baseline
• What are the causes of exchange rate changes?

  1. Inflation rates
  2. Interest rates
  3. Speculation
  4. Other currencies' performance
  5. Government finance
  6. Balance of payments
  7. International competitiveness
  8. Government intervention
• How does lower inflation affect currency value?

  It makes exports more competitive, increasing demand
• What happens when interest rates increase?

  It attracts investment, increasing currency demand
• How does speculation affect currency value?

  Increased demand if future appreciation is expected
• How can government finance impact currency value?

  High debt can lead to depreciation due to lost confidence
• What is the effect of a current account deficit?

  It can lead to currency depreciation
• How does international competitiveness affect currency value?

  Increased competitiveness raises demand for exports
• How does government intervention influence currency value?

  It can maintain a fixed exchange rate
• How does an appreciating exchange rate affect aggregate demand?

  It likely falls as imports become cheaper
• How does a falling pound affect UK exports?

  It makes UK exports more competitive
• How does price inelasticity affect export sales?

  Depreciation won't significantly boost sales
• How does a lower pound affect raw material importers?

  Production costs rise, affecting competitiveness
• How might firms react to a depreciating pound?

  They may keep prices the same to boost margins
• What is a managed float?

  Exchange rate floats with central bank intervention
• How does a fixed exchange rate benefit investment?

  It allows firms to plan without fluctuations
• What is a disadvantage of a fixed exchange rate system?

  Government may not know the market better
• How does a fixed exchange rate provide a target?

  It gives monetary policy a focused target
• What is a drawback of a fixed exchange rate system?

  Balance of payments doesn't adjust automatically
• What is a cost of maintaining a fixed exchange rate?

  It requires large reserves of foreign currencies
• How does a floating exchange rate respond to economic shocks?

  It automatically adjusts to economic shocks
• What freedom does a floating exchange rate provide?

  More freedom to focus on macroeconomic objectives
• What is a drawback of a floating exchange rate system?

  Fluctuations can make investment planning difficult
• How can a floating exchange rate affect unemployment?

  It can cause unemployment in affected industries
• How does a floating exchange rate become vulnerable?

  It can be affected by speculative shocks
• How does a hybrid exchange rate system benefit predictability?

  It makes currency fluctuations more predictable