econ

• Exchange rate


  External price of currency usually measured against another country
• Real exchange rate


  Measure the weighted average value of a country's currency relative to other countries adjusted for inflation
• ERI


  Trade weighted average of the pound exchange rate against currencies
• Calculating percentage change in exchange rate from data presented in index number form


  Quantitative skills worked example
• Freely floating exchange rate


  Exchange rate is determined solely by the interaction of demand for and supply of currency
• Market demand and supply


  Determines the exchange rate to change
• Factors which can cause the exchange rate to change


  • Current account surplus on balance of payments
  • Strong inward investment inflows
  • Relatively high interest rates
  • Speculative currency demand
• Demand for £s increases overseas


  Economic agents (firms & government) buy more £s
• Exports increasing


  Creates an inflow of currency
• Foreign investment flows into the UK economy


  Overseas firms seek a better return in the UK
• Speculators


  Believe that the exchange rate, interest rates or share prices are likely to increase in the future
• Official buying the currency by the central bank


  Bank of England buys £s using its foreign currency reserves
• Supply of £s increases overseas


  Economic agents (firms & government) sell more £s
• UK imports increasing


  Selling sterling in exchange for foreign currency in order to finance their purchases
• Investment flows out of the UK

  Domestic firms seek a better return abroad
• Speculators


  Sell pounds for another currency
• Central banks


  Go into the market & sell to buy other foreign currencies
• Weak GDP growth


  Depreciates the exchange rate & increases the supply of £s
• High interest rates in UK financial institutions


  Appreciate the exchange rate & increases the demand for £s
• Current account deficit


  If exchange rate depreciates, imports become more expensive & current account deficit decreases
• Supply side policies


  Appreciate the exchange rate & increases the demand for £s
• Pound appreciates against the US dollar


  UK input prices rise & UK export prices fall
• Pound appreciates against the US dollar


  Import sales will contract & export sales would expand
• Pound appreciates against the US dollar


  Increases domestic production & domestic jobs
• Pound appreciates against the US dollar

  Decreases trade deficit
• Pound appreciates against the US dollar


  Price of exports become cheaper in foreign currency terms
• Pound appreciates against the US dollar


  Price of imports becomes more expensive in domestic currency terms
• Depreciating exchange rate


  Increases cost of imports can increase cost push inflation
• Depreciating exchange rate


  Increases domestic demand so they could be some demand pull inflation
• Depreciating exchange rate


  Makes exports more competition in the long-term can reduce incentives of firm to cut costs & could lead to declining productivity & rising prices
• Economy is growing quickly & close to full capacity with a fallen exchange rate

  Is likely to increase inflationary pressures
• In a recession a foreign exchange rate may


  Only cost some temporary cost push inflation
• Depreciation


  Will tend to improve the current account balance of payments
• Depreciation


  Exports increase relative to imports, assuming that demand for exports & imports are relatively elastic
• Depreciation


  Cheaper exports so demand for export increases & domestic jobs increased (reduce unemployment)
• Depreciation


  Increases AD so increases real GDP & actual growth