4.5 Exchange Rates (DP IB Economics: HL): Flashcards
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Define an exchange rate.
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Define an exchange rate.
An exchange rate is the price of one currency in terms of another.
What are the three main exchange rate systems?
A floating exchange rate, a fixed exchange rate, and a managed exchange rate system.
Define a floating exchange rate system.
A floating exchange rate system is one in which the forces of demand and supply determine the rate at which one currency exchanges for another.
Define currency appreciation.
Appreciation is a rise in the value of a currency, occurring under a floating system when there is excess demand for it on the forex market.
Define currency depreciation.
Depreciation is a fall in the value of a currency, occurring under a floating system when there is excess supply of it on the forex market.
Under a floating exchange rate system, the forces of demand and determine the value of a currency.
Under a floating exchange rate system, the forces of demand and supply determine the value of a currency.
Define a fixed exchange rate system.
A fixed exchange rate system is one in which the Central Bank intervenes in the currency market to peg the exchange rate in relation to another currency.
Under a fixed system, how does a Central Bank make its currency appreciate?
It buys its own currency on the forex market using its foreign reserves, thereby increasing demand for it.
What is the difference between a revaluation and a devaluation?
A revaluation changes the peg to increase a currency's strength, while a devaluation changes the peg to decrease its strength.
Define a managed exchange rate system.
A managed exchange rate system allows the currency to fluctuate within a specified band, with the Central Bank intervening if it moves outside that band.
True or False?
Central banks publish the exact bands they use in a managed exchange rate system.
False.
The bands are not published, as this would help currency speculators anticipate interventions and profit from them.
Under a managed system, how does a Central Bank stop its currency rising above the band?
It sells its own currency (buying foreign reserves), increasing supply to bring the currency back within the band.
True or False?
Currently, almost all of the world's currencies are pure floating currencies.
False.
Currently, almost all currencies are managed currencies.
How does a rise in UK interest rates affect the value of the pound?
A higher UK interest rate increases foreign demand for pounds (hot money inflows), causing the pound to appreciate.
How does relatively higher UK inflation affect the pound?
Higher relative inflation makes UK exports more expensive, so demand for them and for pounds falls and the pound depreciates.
Net foreign direct investment into the UK creates a demand for the pound, which leads to the pound .
Net foreign direct investment into the UK creates a demand for the pound, which leads to the pound appreciating.
Define currency speculation.
Speculation occurs when traders buy a currency expecting it to be worth more in the short to medium term, then sell it to realise a profit.
How do remittances affect a country's currency?
High levels of remittances help keep demand for a country's currency strong, for example in the Philippines.
True or False?
A country with a stronger economic growth rate tends to see its currency depreciate.
False.
Stronger growth attracts higher levels of FDI, which results in the currency appreciating.
How can a change in tastes cause a currency to appreciate?
Rising global demand for a country's exports raises demand for its currency, for example fashionable quinoa put upward pressure on Bolivia's Boliviano.
Define a currency depreciation.
A depreciation is a fall in the value of a currency, which makes exports cheaper and imports more expensive.
How does a currency depreciation tend to affect aggregate demand and growth?
Cheaper exports and dearer imports should raise net exports, increasing aggregate demand and leading to economic growth.
How can a depreciating currency cause cost-push inflation?
A weaker currency raises the price of imported raw materials, increasing firms' costs of production and causing cost-push inflation.
True or False?
A currency depreciation always improves the current account, whatever the elasticities involved.
False.
The extent depends on the price elasticity of demand for exports and imports; the improvement is largest when demand for exports is price elastic.
If a depreciation leads to an increase in exports, unemployment is likely to .
If a depreciation leads to an increase in exports, unemployment is likely to fall.
Why can the effect of a depreciation on living standards be muted?
Dearer imports leave households with higher prices and less choice, which offsets the gains from rising exports, higher wages and lower unemployment.
Define a fixed exchange rate system.
In a fixed exchange rate system, the central bank actively intervenes to maintain the fixed rate.
What are the main advantages of a fixed exchange rate system?
It provides stability and predictability for international trade and investment and lowers speculative trading and volatility, though it limits monetary policy autonomy.
Define a floating exchange rate system.
In a floating exchange rate system, the currency's value is determined by the market forces of supply and demand.
What is the main advantage of a floating exchange rate system?
It allows greater flexibility in conducting independent monetary policy and automatic adjustments to external shocks, though with greater exchange rate volatility.
Under a fixed system, monetary policy is limited because the focus is on the exchange rate and not the rate.
Under a fixed system, monetary policy is limited because the focus is on the exchange rate and not the interest rate.
True or False?
A fixed exchange rate system increases speculative trading and currency volatility.
False.
A fixed exchange rate system lowers speculative trading and currency volatility.
What does the choice between a fixed and floating system depend on?
It depends on a country's macroeconomic goals, its stability objectives, and the external economic environment.
Why did the Swiss Central Bank remove its euro peg in 2015?
It could no longer afford to keep supplying enormous reserves of CHF to hold the peg against strong demand for the franc.
Why was demand for the Swiss Franc so strong before the peg was removed?
Deteriorating conditions in Russia after its takeover of Crimea drove investors to seek a safe haven for their money in Switzerland.
What happened to the Swiss Franc once the peg was removed?
The Swiss Franc appreciated significantly against the euro as investors demanded it.
How did the franc's appreciation affect Swiss exporters?
The stronger franc made Swiss products more expensive and less competitive in international markets.
True or False?
The appreciation of the Swiss Franc created inflationary pressure in Switzerland.
False.
It increased deflationary pressure, as imported goods became cheaper and domestic producers faced greater competition.
When the Swiss Franc appreciated, Switzerland became a more expensive destination for foreign tourists, causing a decrease in revenue.
When the Swiss Franc appreciated, Switzerland became a more expensive destination for foreign tourists, causing a decrease in tourism revenue.
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