International economics (Part 2)

• Exchange rates are the value of one currency expressed in terms of another
• Bilateral = rates between 2 countries (e.g. £1 = $1.20)
• Exchange rate systems:

  Floating exchange rate = where the value of a currency is determined by the free market force (i.e. demand & supply) and therefore changes on a day to day basis
• Exchange rate systems:

  Fixed exchange rate = A rate of exchange between at least two currencies which is constant over time (i.e. China)
• Exchange rate system:

  Managed exchange rate = when the value of a currency is determined by the free market forces but governments intervene occasionally to alter its value (i.e. CB intervening to meet specific Macro objectives)
• Appreciation: When the value of a currency rises because of market forces
• Depreciation: When the value of a currency falls because of market forces
• Revaluation: When policymakers officially fixes a new higher value for the currency in a fixed exchange rate
• Devaluation: hen policymakers officially fixes a new lower value for the currency in a fixed exchange rate
• Factors affecting floating equilibrium exchange rate

  1. International trade in goods & services (change in Exports = demand, change in Imports = supply)
• Factors affecting floating equilibrium exchange rate:

  2. Long term investments (FDI): if economy is growing fast = increase in demand for the pound, if economy is growing slower in comparison to a foreign country = supply of pound to get foreign currency
• Factors affecting floating equilibrium exchange rate:

  3. Speculation: Speculators who believe value of the pound will rise = higher demand, Speculators who believe value of the pound will drop = increase supply
• Factors affecting floating equilibrium exchange rate:

  4. Interest rates: UK with high IR = more hot money = increase in demand, Foreign countries with higher IR than UK = hot money flows out = increase in supply
• Factors affecting floating equilibrium exchange rate:

  5. UK Inflation: Lower inflation make our exports more price competitive = increase in demand for pounds. Higher inflation will make imports more attractive = increase in supply of pounds
• The self correcting theory suggests that int the free-floating exchange market, the balance of payments will adjust automatically based on changes in the exchange rate. Like the UK, a country that has a trade deficit (x<m) will devalue their currency, making its exports cheaper to the rest of the world causing a surplus.
• The J curve:

  The J-curve is an evaluation for the self correcting system, arguing that In the short term, depreciation may not improve the current account deficit, This is because in the short-term the price elasticity of demand for exports and imports are inelastic as contracts will have been signed and there are still time lags to consider
• The J curve:

  A) Short-run

  B) Long-run

  C) Surplus

  D) Defecit

  
• The Marshall learner condition:

  The Marshall learner condition states that a depreciation/devaluation of the exchange rate will lead to an improvement in net trade PROVIDED that the sum of the price elasticity of demand for exports and imports is > 1 (elastic)
• Reverse J Curve:

  The reverse J-curve shows that if your currency appreciates you may see an increase in the current account surplus however, in the Long-term you will see a trade deficit as exports become less internationally competitive

  
• CID & DEC:

  • As the value of a currency appreciates: imports become cheaper and exports become dearer
  • As the value of the currency depreciates: imports become dearer and exports become cheaper