Balance of Payments + E/R

• What is the exchange rate of a currency?

  Weight of one currency relative to another
• How is the value of a currency determined in a floating exchange rate system?

  By the forces of supply and demand
• What happens to the exchange rate when demand increases in a floating system?

  It appreciates to a higher value
• What is the formula for demand for a currency?

  Exports plus capital inflows
• What is the formula for supply of a currency?

  Imports plus capital outflows
• How is a fixed exchange rate determined?

  By the government compared to other currencies
• How can a central bank manipulate the supply of currency in a fixed exchange rate system?

  By buying or selling the currency
• What happens to the currency when the supply is increased in a fixed exchange rate system?

  It depreciates, making exports competitive
• What characterizes a managed exchange rate system?

  Combines fixed and floating exchange rate features
• What does revaluation mean in currency terms?

  Adjustment of currency value relative to a baseline
• What is appreciation of a currency?

  When the value of a currency increases
• What is devaluation in currency terms?

  Official lowering of currency value in fixed system
• What is depreciation of a currency?

  When the value falls relative to another currency
• How does inflation affect floating exchange rates?

  Lower inflation increases currency competitiveness
• How does speculation influence currency value?

  Increased demand if appreciation is expected
• How do government finances impact currency value?

  High debt risks default, causing depreciation
• What happens when imports exceed exports?

  Current account deficit occurs
• How does international competitiveness affect currency value?

  Increased competitiveness raises currency demand
• How do interest rates influence currency value?

  Higher rates attract investment, causing appreciation
• What is quantitative easing?

  Stimulates economy by increasing money supply
• How does the Bank of England manage foreign currency reserves?

  By buying and selling foreign currency
• What is competitive devaluation?

  Devaluing currency to make exports cheaper
• What are the consequences of a devalued currency?

  Exports cheaper, imports more expensive
• How does a weaker exchange rate affect employment?

  Increases exports, potentially creating jobs
• How does depreciation affect inflation?

  Increases costs of imports, causing inflation
• What is foreign direct investment (FDI)?

  Capital flow for lasting interest in enterprise
• How does currency depreciation affect FDI?

  Makes country more competitive, attracting FDI
• What does the acronym SPICED stand for in relation to exchange rates?

  • Strong
  • Pound
  • Imports
  • Cheap
  • Exports
  • Dear
• What are the effects of a reduction in the exchange rate on the current account?

  • Exports become cheaper, increasing demand
  • Imports become more expensive, reducing demand
  • Current account deficit improves if demand is price elastic
• What is the Marshall-Lerner condition?

  • A devaluation improves balance of trade
  • Requires sum of long-run export and import demand elasticities ≥ 1
• What is the J-curve effect in relation to currency devaluation?

  • Initial increase in import costs worsens deficit
  • Long-term reduction in trade deficit as exports increase
  • Time lag in changing export/import volumes
• How do exchange rates affect aggregate demand (AD)?

  • Appreciation reduces AD as imports rise
  • Depreciation increases AD as exports rise
  • Influenced by inflation rates and price elasticity
• What are the potential impacts of a weaker exchange rate on the economy?

  • Increased exports boost sales and profits
  • Job creation in export sectors
  • Potential job losses in import-dependent industries
• What is the balance of payments?

  A record of financial transactions between countries
• What does the balance of payments indicate about imports and exports?

  It shows spending on imports and value of exports
• What are exports in the balance of payments?

  Goods and services sold to foreign countries
• Why are exports considered positive in the balance of payments?

  They represent an inflow of money
• What are imports in the balance of payments?

  Goods and services bought from foreign countries
• Why are imports considered negative in the balance of payments?

  They represent an outflow of money
• What are the main components of the balance of payments?

  • Current account
  • Capital account
  • Financial account