Exchange rates

Question	Answer
What is the exchange rate ?	The price of one currency in terms of another. The external value of a currency.
In a floating exchange rate system, the price is determined by .....	market forces of supply and demand
In a fixed system, the government ....	intervenes to maintain the external value of the currency
What is the equilibrium exchange rate ?	Where the supply of the currency = the demand for the currency
In a floating exchange rate system, an increase in the exchange rate is an ..... a fall is a	appreciation depreciation
In a fixed exchange rate system, if the rate at which it is fixed is increased, this is called a .. A lower rate is a	Revaluation Devaluation
Define real exchange rate	Takes inflation into account
The demand for pounds refers to	the desire to change other currencies into pounds
The pound is demanded to	1. Spend on UK goods and services 2. Save in UK banks and other financial institutions 3. Speculate on the currency in the hope that the pound will become more valuable in the future (hot money)
The demand for the pound will increase if: (3 marks)	1. UK goods and services are demanded more e.g. quality improves, incomes increase, relatively cheaper, tourism. 2. UK interest rates increase - Hot money effect, greater desire to save in UK to earn higher rates of interest 3. People think the value of the £ will rise in the future so buy now
If the pound falls, the price of UK goods and services in foreign currency ... causing demand to	falls causing demand to increase
The more price elastic the demand for UK goods and services, the more ..... the demand for pounds	elastic
The supply of pounds (sterling) refers to the desire to	Change pounds into other currencies
There may be a desire to change £ into other currencies in order to ... ( 3 marks )	1. Buy overseas goods and services; travel abroad 2. Save in overseas institutions 3. Speculate on a foreign currency in the hope that it will increase in value
If the UK exchange rate falls, then the price of imports in UK currency ..... This will ..... the amount of imports which are bought	increases reduce
The supply of pounds will increase (shift outwards) when : ( 3 marks )	1. Overseas interest rates increase so saving abroad becomes more attractive 2. Overseas goods are demanded more e.g. better quality, UK incomes rise, foreign goods are relatively cheaper, increased tourism abroad 3. People think the pound will fall in the future so they sell it now.
What are the main advantages of a floating exchange rate system ? ( 5 marks )	1. Exchange rate automatically adjusts so that supply of currency equals demand - automatically eliminating BOP deficits or surpluses. 2. No need for central bank to keep foreign reserves 3. Government can pursue its own domestic policies e.g. adjust interest rates more easily. 4. Prevents imported inflation - one country has a higher inflation rate, then, under fixed ER system, another country will import those via higher import prices. 5. Possibly reduces speculation because speculators might lose and so do not take risks.
What are the main disadvantages of a floating exchange rate system ? ( 2 marks )	1. Causes instability, deterring investment and trade 2. Leads to cost-push inflation. e.g. relatively high inflation in UK causes goods to be un-competitive, leads to fall in demand for currency and fall in exchange rate. Makes goods competitive again but makes imports more expensive, leading to cost-push inflation in long-term.
How might the government influence the exchange rate ? ( 2 MARKS )	1. Buying and selling currency 2. Changing interest rates to influence capital inflows and outflows from the economy
To decrease the exchange rate for the currency a government may : (2 marks)	1. Buy the currency 2. Raise interest rates to attract investors
With a fixed exchange rate, the government intervenes to maintain the exchange rate. If the price of the currency is about to fall, the government may ....... by buying its own currency using ......, or increasing ......	increase demand foreign currency reserves interest rates
If the price of the currency is about to increase, the government may ..... its own currency or ..... interest rates	sell lower
What are the main advantages of fixed exchange rates ? ( 2 marks )	1. Provide stability for firms and households , encouraging investment and trade 2. Act as a constraint on domestic inflation
Disadvantages of fixed exchange rates 2 marks	1. Government must have sufficient reserves to intervene to maintain the price of its currency 2. A country's firms may be uncompetitive if the exchange rate is fixed at too high a rate
If the exchange rate is fixed above the equilibrium rate, there will be ..... supply of the currency, causing a balance of payments .....	excess Deficit
If the price is fixed below the equilibrium, there is ....... demand for the currency, meaning that there is a balance of payments ......	excess Surplus
If there is a current account deficit, there must be a ..... on the capital and financial accounts Why ?	surplus. To fund the current account deficit caused by money leaving the country, assets must be sold to bring money in.
What may be done to reduce a balance of payments current account surplus ? ( 3 marks )	1. Reflate to boost demand and so increase imports 2. Remove import controls 3. Revalue the currency
How can the government improve the UK's international competitiveness ? ( 5 marks )	1. Lower interest rates to stimulate investment 2. Tax incentives for R&D and investment 3. Help Entrepreneurs start up by reducing regulatory burden and bureaucracy 4. Encourage the sharing of ideas and 'best practice' 5. Reduce protectionist barriers to stimulate competition.

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	Created by callum_j.smith almost 10 years ago