Economics - ECON4 - AQA - Exchange Rates - Book notes - Chapter 18

CHAPTER 18

EXCHANGE RATES

Floating ER – determined by D+S

Fixed ER – set & maintained by govt

Managed float – govt recognises market forces but intervenes periodically

FLOATING EXCHANGE RATES

ER = price of one currency in terms of another

Others currency for a variety of reasons:

- Purchase each other’s G+S

Invest in each other’s firms

Speculate

Funds into each other’s banks when IR increases

Appreciation – floating ER value up

Depreciation – value down

Change in ER leads to change in relative P of X&M

Global trend towards ER determined by market, but govt will still intervene

Advantages:

Continuous and automatic as foreign exchange market changes rate automatically to reflect the purchasing power of one currency against another. If large B of P deficit find ER down and £X down

Reduced speculative pressure – if fixed speculators can sell currency, forcing govts to reduce value of currency. Floating – cannot be forced to depreciate ER. Speculators do not know how low govt will let it get

Reduce need 4 govts to hold large forex reserves as do not have to maintain ER level.

Disadvantages:

No guarantee that it will solve B of P problems – total spend depends on PeD

Domestic inflation – if ER…