Exchange Rates | Notes
What is an exchange rate?
The price of a currency in terms of another
What is a fixed exchange rate?
The value of the currency is controlled by the central bank.
The central bank uses reserves of their own currency and a foreign currency.
For example, China want to maintain a weak exchange rate (relative to the dollar).
China can buy and sell reserves of their own currency or a foreign currency.
They can either:
- buy more Dollars by selling more Yuan
- buy more Yuan by selling more Dollars
How does a central bank devalue a currency?
- sell more of your currency
- use it to buy the foreign currency
How does a central bank revalue a currency?
- buy more of your currency
- sell more of the foreign currency
What is a floating exchange rate?
The value of the currency is determined by market forces (supply and demand).
What are three factors that affect floating exchange rates?
- demand for exports
- an increase in demand for exports would mean
- an increase in demand for the pound which would cause an
- appreciation of the pound
- demand for imports
- an increase in demand for imports would mean
- an increase in supply of the pound which would cause a
- depreciation of the pound
- interest rates
- if there is a decrease in UK interest rates
- there would be hot money flows out of the economy
- the pound would depreciate
Two ways a stronger currency affects the economy?
- left shift in AD
- right shift in SRAS
Two ways a weaker currency affects the economy?
- right shift in AD
- left shift in SRAS
What is the J-curve?
What is the Marshall-Lerner condition?
Summary questions
- What is an exchange rate?
- What is a fixed exchange rate?
- How does a central bank devalue a currency?
- How does a central bank revalue a currency?
- What is a floating exchange rate?
- What are three factors that affect exchange rates?
- How does a stronger currency affect the economy?
- How does a weaker currency affect the economy?
- What is the J-curve?
- What is the Marshall-Lerner condition?