Podcast
Questions and Answers
Define the term exchange rate.
Define the term exchange rate.
The price of one currency in terms of another.
Explain how increased tourism from Europe to the USA affects the Euro/USD exchange rate.
Explain how increased tourism from Europe to the USA affects the Euro/USD exchange rate.
It increases demand for USD and increases the supply of Euros, leading to the appreciation of the USD and depreciation of the Euro.
Describe one advantage and one disadvantage of a fixed exchange rate system.
Describe one advantage and one disadvantage of a fixed exchange rate system.
Advantage: Provides certainty for firms in agreeing on prices. Disadvantage: Requires regular intervention by the Central Bank, which can be expensive.
What is the difference between a revaluation and a devaluation?
What is the difference between a revaluation and a devaluation?
Explain how a depreciating currency can lead to cost-push inflation.
Explain how a depreciating currency can lead to cost-push inflation.
Explain how a currency depreciation may improve a country's current account balance.
Explain how a currency depreciation may improve a country's current account balance.
How might a fixed exchange rate system negatively impact domestic consumption and investment?
How might a fixed exchange rate system negatively impact domestic consumption and investment?
Under a fixed exchange rate system, what actions must a central bank take if there is an excess supply of their currency on the forex market and they wish to maintain their peg?
Under a fixed exchange rate system, what actions must a central bank take if there is an excess supply of their currency on the forex market and they wish to maintain their peg?
Assuming the Marshall-Lerner condition holds, how does the J-curve effect relate to currency depreciation and the trade balance in the short run?
Assuming the Marshall-Lerner condition holds, how does the J-curve effect relate to currency depreciation and the trade balance in the short run?
A country pegs its currency to the US dollar. Due to significant capital flight, the central bank is running low on foreign reserves. Describe a scenario where imposing capital controls might be a more feasible short-term solution than devaluing the currency, and what are the potential drawbacks?
A country pegs its currency to the US dollar. Due to significant capital flight, the central bank is running low on foreign reserves. Describe a scenario where imposing capital controls might be a more feasible short-term solution than devaluing the currency, and what are the potential drawbacks?
Flashcards
Exchange Rate
Exchange Rate
The price of one currency expressed in terms of another currency, for example, £1 = €1.18.
Currency Appreciation
Currency Appreciation
When there is more demand than supply for a currency on the forex market, its price increases.
Currency Depreciation
Currency Depreciation
When there is more supply than demand for a currency on the forex market, its price decreases.
Fixed Exchange Rate System
Fixed Exchange Rate System
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Revaluation
Revaluation
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Devaluation
Devaluation
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Impact of Currency Depreciation
Impact of Currency Depreciation
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Impact of Currency Appreciation
Impact of Currency Appreciation
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Central Bank Intervention
Central Bank Intervention
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Interest Rate Influence
Interest Rate Influence
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Study Notes
- An exchange rate represents the price of one currency in terms of another.
- A country's Central Bank controls the exchange rate system to determine the value of its currency.
- Two main exchange rate systems exist.
- Excess demand for a currency on the forex market leads to price increases (appreciation).
- Excess supply of a currency on the forex market leads to price decreases (depreciation).
- The Euro/US$ market involves two diagrams: one for the USD and one for the Euro.
- Initial equilibrium is at P1Q1 in both markets.
- When Europeans visit the USA, they demand US$ and supply Euros.
- Increased US$ demand shifts the demand curve right, appreciating the $ from P1 to P2, forming a new equilibrium at P2Q2.
- Increased Euro supply shifts the supply curve right, depreciating the Euro from P1 to P2, forming a new equilibrium at P2Q2.
Fixed Exchange Rates
- Involves a Central Bank intervening to fix (peg) the exchange rate to another currency.
- To appreciate its currency, the Central Bank buys it on forex markets using foreign reserves, increasing demand.
- To depreciate its currency, the Central Bank sells it on forex markets, increasing supply.
- Sometimes pegged at parity.
- Often the peg is not at parity
- A revaluation occurs when the Central Bank increases the currency's strength.
- A devaluation occurs when the Central Bank decreases the currency's strength.
Advantages of Floating Exchange Rates
- Natural fluctuations maintain stable current account balances.
- Currency depreciation increases exports and reduces imports.
- Currency appreciation may decrease costs of raw materials, which may help lower prices in the economy
Disadvantages of Floating Exchange Rates
- Fluctuations create uncertainty for firms, potentially reducing investment.
- Currency depreciation may cause costs of raw materials to increase resulting in cost push inflation
Advantages of Fixed Exchange Rates
- Even with rising export demand, export prices remain fixed as the currency won't appreciate, potentially boosting sales over time.
- Central Bank intervention is necessary to maintain the rate, which can be expensive.
- Firms benefit from price certainty due to stable exchange rates.
Disadvantages of Fixed Exchange Rates
- Interest rate changes can influence the exchange rate.
- Interest rate adjustments to maintain a fixed rate can negatively impact consumption, investment, lending, saving, and borrowing.
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Description
Understand exchange rates, their determination, and the impact of supply and demand. Learn about fixed exchange rates and central bank intervention in currency markets. Explore the dynamics of currency appreciation and depreciation.
