4.1.8- exchange rates

• What happens to a currency when demand increases?

  The currency gets stronger
• What happens to a currency when supply decreases?

  The currency gets weaker
• How do imports and exports affect currency value?

  Imports increase supply; exports increase demand
• What is speculation in currency trading?

  Buying low and selling high based on predictions
• How would an investor profit from currency speculation?

  Buy pounds when cheap, sell when expensive
• What does speculation of future appreciation cause?

  It causes a present appreciation now
• What does a prediction of depreciation lead investors to do?

  Sell pounds now, causing depreciation
• How do relative interest rates affect currency value?

  Higher rates increase demand, appreciating currency
• What happens when base rates decrease?

  It increases supply of the currency
• How does a lower inflation rate affect currency value?

  It increases demand, leading to appreciation
• What is the effect of FDI on currency demand?

  It increases demand for the currency
• How does quantitative easing affect currency value?

  It increases supply of money, causing depreciation
• What are the impacts of changes in exchange rates?

  • Growth and employment
  • Inflation rate
  • FDI flows
  • Current account
• How does depreciation affect growth and employment?

  It leads to an increase in growth
• What happens to import expenditure when currency appreciates?

  Import expenditure increases, revenue decreases
• How does currency depreciation affect inflation?

  It can cause demand-pull and cost-push inflation
• What is the effect of a depreciating exchange rate on FDI?

  It can lead to more FDI investment
• How can concerns about depreciation affect FDI?

  It might scare investors, leading to less FDI
• What happens to FDI when currency appreciates?

  FDI decreases due to higher investment costs
• How does an appreciating currency affect the current account?

  It worsens the current account balance
• What happens to the current account when currency depreciates?

  It improves due to cheaper exports
• What is the J-curve effect in exchange rates?

  Short-run inelastic demand leads to worsened CA
• What is the Marshall-Lerner condition?

  PED for exports + PED for imports > 1
• What must happen before the current account improves after depreciation?

  The Marshall-Lerner condition must be satisfied
• How do interest rates manage exchange rates?

  Higher rates attract hot money, appreciating currency
• What happens when a central bank sells its own currency?

  It increases supply, leading to depreciation
• What are the types of exchange rate systems?

  • Fixed exchange rates
  • Managed exchange rates
  • Floating exchange rates
• What is a fixed exchange rate?

  It fixes one currency to another currency
• How does a central bank intervene in fixed exchange rates?

  By changing interest rates or using currency transactions
• What is revaluation in fixed exchange rates?

  Increasing the fixed exchange rate
• What is devaluation in fixed exchange rates?

  Decreasing the fixed exchange rate
• What are managed exchange rates?

  Central bank intervenes to keep rates within a range
• What are floating exchange rates?

  Rates are determined by market factors
• What is the nominal exchange rate?

  Price of one currency in terms of another
• What is the real exchange rate?

  Nominal rate adjusted for price levels
• How is the real exchange rate calculated?

  Nominal rate x domestic price level / foreign price level
• What does the real exchange rate indicate?

  Currency worth relative to goods and services