Exchange Rate

• What is the definition of exchange rate?

  The price of one currency in terms of another
• What do floating exchange rates depend on?

  Supply and demand of the currency
• What effect does appreciation have on imports and exports?

  Makes imports cheaper and exports more expensive
• What does the acronym S.P.I.C.E.E. stand for in relation to exchange rates?

  • S: Stronger
  • P: Pound
  • I: Imports
  • C: Cheaper
  • E: Exports
  • E: Expensive
• What happens if the supply of the £ increases?

  Exchange rate decreases, leading to depreciation
• What is the effect of increased demand for £?

  Exchange rate increases, leading to appreciation
• What factors influence the supply and demand for a currency?

  • Imports and exports
  • Speculation
  • Relative interest rates
  • Relative inflation rates
  • Foreign Direct Investment (FDI)
  • Quantitative easing
• What happens if UK consumers reduce pork imports?

  Supply of £ decreases, increasing exchange rate
• What is the impact of UK government regulations on arms exports?

  Decreases demand for £, lowering exchange rate
• How does foreign travel by UK consumers affect the supply of pounds?

  Increases supply of pounds, decreasing exchange rate
• What happens when Chinese consumers travel to the UK?

  Increases demand for pounds, appreciating exchange rate
• How do imports and exports affect the supply and demand curves?

  • Imports: Supply curve shifts left
  • Exports: Demand curve shifts right
• What do currency speculators aim to do?

  Buy low and sell high for profit
• What does speculation of future appreciation cause?

  Present appreciation due to increased demand
• What should investors do if they expect depreciation in 7 months?

  Sell pounds now and buy later
• What happens when interest rates increase in the UK?

  Increases demand for £, appreciating exchange rate
• What occurs if UK interest rates decrease?

  Increases supply of £, depreciating exchange rate
• How do relative inflation rates affect consumer behavior?

  Consumers buy from countries with lower inflation
• What happens to demand for a currency with higher inflation in its country?

  Decreases demand for that currency
• What is Foreign Direct Investment (FDI)?

  Investment by a firm in another country
• What effect does increased FDI have on currency demand?

  Increases demand for the currency, appreciating exchange rate
• What is quantitative easing?

  Monetary policy to grow the economy
• What does quantitative easing involve?

  Central bank buys financial assets to increase money supply
• What was the effect of the Bank of England's quantitative easing from 2009 to 2012?

  Increased supply of £, depreciating exchange rate
• What is a positive trade balance?

  • Exports greater than imports
  • Increases export revenue
  • Decreases import expenditure
  • Currency appreciates
• How does India's inflation rate compared to China's affect its currency?

  Higher inflation decreases demand for Indian exports
• What happens to the demand for rupees if Indian exports decrease?

  Demand for rupees decreases, leading to depreciation
• What happens to the exchange rate with increased FDI?

  Shifts demand for pounds right, appreciating exchange rate
• What are the impacts of changes in exchange rates on growth and employment?

  • Depreciation makes exports cheaper
  • Increases AD and Real GDP
  • Increases derived demand for labor
  • Increases employment
  • Increases cost of imports, shifting SRAS left
• What are the impacts of changes in exchange rates on inflation?

  • Depreciation increases export revenue
  • Increases AD, leading to demand-pull inflation
  • Increases cost of imports, causing cost-push inflation
• What are the impacts of changes in exchange rates on FDI flows?

  • Depreciation leads to more FDI flows
  • Investment becomes cheaper
  • Appreciation makes FDI more expensive
• What are the impacts of changes in exchange rates on the current account?

  • Appreciation: imports cheaper, exports expensive
  • Decreases UK current account
  • Depreciation: imports expensive, exports cheaper
  • Increases UK current account
• Why is import demand inelastic in the short run?

  Importers can't immediately respond to exchange rate changes
• How do changing interest rates manage exchange rates?

  • Higher interest rates: increase demand for £, appreciation
  • Lower interest rates: increase supply of £, depreciation
• What are infant industries?

  • Industries too young for economies of scale
  • Producing low levels of output
• What happens when a central bank sells its local currency for foreign currencies?

  Increases supply of local currency, depreciating exchange rate
• What is the effect of competitive depreciation?

  Can lead to a currency war among countries
• What are hot money flows?

  Money moved internationally for short-term profit
• What is the purpose of hot money flows?

  Maximize interest received on investments
• floating exchange rate

  when the value of a currency changes freely based on supply and demand for a currency (left to market forces)