Econs Notes Chapter 26

Economics Test – Chapter 26: Exchange rates
 Exchange rates = the price of one currency expressed in the terms of other
currency
 Exchange rate system = the way that a country manages its exchange rate
(exchange-rate regime)
1. Define, explain, and give examples of a fixed and a floating

exchange rate system.
 Fixed exchange rate:

o An exchange-rate regime where the value of a currency is fixed, or
pegged, to the value of another currency
o To the average value of selection of currencies, or to the value of some
other commodity
 Floating exchange rate:
o An exchange-rate regime where the value of a currency is allowed to be
determined solely by the demand for, and supply of, the currency on the
foreign exchange market
2. Distinguish between a devaluation and a revaluation of a currency.

(only in the fixed exchange rate system)
 Revaluation = if the value of the currency is raised

 Devaluation = if the value of the currency is lowered
3. Distinguish between depreciation and appreciation of currency.

(only in the floating exchange rate system)
 Appreciation = if the value of the currency increases

 Depreciation = if the value of the currency falls
4. Calculate exchange rates and changes in exchange rates.
 PAST PAPER QUESTION

 May 2015 paper 3 Q3 (page 133 - 135)
5. Describe factors leading to changes in the demand for, and supply
of, a currency.
??????????????????????????????????????????????????????????????????
6. Define, explain, and give examples of a managed exchange rate

system.
 Exchange-rate regimes where the currency is allowed to float but with some
element of interference from the government
 The government usually sets a range between which the exchange rate should
remain
 Intervention may involve the interest rate being manipulated or the currency
being bought or sold
7. Evaluate the advantages and disadvantages of high and low

exchange rates.
 High exchange rates:

 Advantages:
o Downward pressure on inflation: price of finished goods will be relatively
low, price of imported raw materials will reduce costs of production
 lower prices for consumers + puts pressure on domestic products to
be competitive
o More imports can be bought: each unit of the currency will buy more
foreign currencies and so more foreign goods and services
o A high value of currency forces domestic producers to improve their
efficiency: can threaten the international competitiveness so they will be
forced to lower costs and become more efficient  greater economic
productivity
 Disadvantages:
o Damage to export industries: export industries may find it difficult to sell
their goods and services abroad because of their relatively high prices
 lead to unemployment
o Damage to domestic industries: greater levels of imports being
purchased – domestic producers may find that increased competition
causes a fall in demand
 Low exchange rates:

 Advantages:
o Greater employment in export industries: exports from the country will
be relatively less expensive and so more competitive  more
employment
o Greater employment in domestic industries: make imports more
expensive  encourage domestic consumers to buy domestically
produced goods
8. Explain government measures to intervene in the foreign exchange

market.
 Using their reserves of foreign currencies to buy, or sell, foreign currencies:

o To increase the value of the currency  can use its reserves of foreign
currencies to buy its own currency on the foreign market – increase
demand and force up exchange rates
o To lower the value of the currency  buys foreign currencies on the
foreign exchange market increasing its foreign reserves – increases the
supply and lowers exchange rates
 By changing interest rates:

o To increase the value of the currency: raise the level of interest rates –
make the domestic interest rates relatively higher than those abroad
 attract financial investment (investors will have to buy the country’s
currency  increasing demand and exchange rates)
o To lower the value of the currency: lower the level of interest rates –
make domestic interest rates relatively lower than those abroad
 make financial investment abroad more attractive (investors will have
to buy foreign currencies  exchanging their own currency, increasing
supply and lower exchange rates)
9. Compare and contrast a fixed exchange rate system with a floating
exchange rate system.
 Floating exchange rate system:

 Advantages:
o Monetary policy can continue to be used as the government is not
intervening in the pricing of the currency  the interest rate can be
manipulated to encourage growth as the currency is able to depreciate
freely
o Trade imbalances can naturally adjust: if the currency appreciates
because of the demand for exports increasing  then this demand will
gradually fall because the price of exports increases as the currency
appreciates
o These exchange rate changes are smooth and continuous
o Speculation may be lower as there is no strict value that is perceived to
be ideal of the currency to be at, therefore, there is less opportunity to
make a profit on the changes in its value
o The central bank does not need to hold ass much in foreign reserves

 Disadvantages:
o There is increased uncertainty as the exchange rate has no fixed value,
so investors, exporters and importers face greater risks and be less
confident in the market  lower rates
o The government may be more likely to employ inflationary policies to
achieve short term growth
 Fixed exchange rate system:

 Advantages:
o There is less uncertainty as the currency maintain its fixed value  safer
opportunity for investors
o Inflationary growth is not an option, so the government must act with
discipline in reaching its macroeconomic aims
o The exchange rate can be manipulated to combat high inflation

 Disadvantages:
o The government cannot use monetary policy  affect the exchange rate
o Expansionary fiscal policy cannot be used to finance a deficit - affect the
money supply and interest rates
o The exchange adjustments are abrupt which could be very disruptive
o Trade deficits cannot automatically be corrected, instead contractionary
fiscal policy may be necessary
o The central bank must keep large foreign exchange reserves so that they
can intervene in the exchange rate

Econs Notes Chapter 26

Uploaded by

Copyright:

Available Formats

Econs Notes Chapter 26

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Econs Notes Chapter 26

Uploaded by

Copyright:

Available Formats

Economics Test – Chapter 26: Exchange rates

1. Define, explain, and give examples of a fixed and a floating

 Fixed exchange rate:

2. Distinguish between a devaluation and a revaluation of a currency.

 Revaluation = if the value of the currency is raised

3. Distinguish between depreciation and appreciation of currency.

 Appreciation = if the value of the currency increases

 PAST PAPER QUESTION

6. Define, explain, and give examples of a managed exchange rate

7. Evaluate the advantages and disadvantages of high and low

 High exchange rates:

 Low exchange rates:

8. Explain government measures to intervene in the foreign exchange

 Using their reserves of foreign currencies to buy, or sell, foreign currencies:

 By changing interest rates:

 Floating exchange rate system:

 Fixed exchange rate system:

You might also like