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Macroeconomics: Exchange Rates (Effect of a currency appreciation on…
Macroeconomics: Exchange Rates
Floating exchange rate:
Value of currency determined purely by demand and supply, with no intervention from BOE
Floating vs Fixed
:
Fixed
Stability helps to control cost and price inflation
Imposes responsibility on government
Certainly gives confidence for investment
Less speculation if the fixed rate is creadiable
Floating
Freedom to set interest rates
Prevents imported inflation
Insulation of economy after external shock
Automatic adjustment for a current account deficit
Managed exchange rate:
Mixture of fixed and floating where government may intervene by buying to support and selling to weaken currency
Fixed Exchange Rate:
Occurs when a country tries to keep the value of its currency at a certain level against another currency
To support a fixed exchange rates the central bank holds both domestic and forgiven current reserves. This is an expensive method.
For a STRONG POUND the BOE needs to self domestic reserves and buy forgiven currency reserves in order to shift demand by devaluing the pound
For a WEAKER POUND the BOE needs to sell forgiven reserves to buy more domestic reserves to increase demand and value.
S-Strong P-Pound I-Imports C-Cheaper E-Exports D-Dearer
Exchange Rate:
The price of one currency in terms of another
Effect of a currency appreciation on imports
1.Appreciation of currency
Rise in external purchasing power
Cheaper to import goods and services
Rising demand for imports
Worsening of trade balance
Fall in aggregate demand
Lower currency can affect Macro Objectives
Export demand and trade balance
Weaker currency makes exports cheaper overseas
Rising export sales & a stronger trade balance
Real GDP and jobs
Rise in exports and fall in imports will increase AD
Higher export profits is boost to the labour market
Inflation
Causes a rise in cost push inflationary pressure
A fall in a currency leads to a rise in import prices