4.1.8 -part 2

Question 1

State marshall lerner condition

Answer 1

A depreciation of the domestic currency will improve the trade balance if the sum of price elasticities of demand for exports and imports is greater than 1.

Question 2

What is j curve effect

Answer 2

In the short term, a depreciation may initially worsen the trade balance before improving it, as it takes time for demand elasticities to adjust. (PED is inelastic short term, elastic in long term)

Question 3

Reasons for J curve effect

Answer 3

1) contracts - contracts prevent some firms from immediately switching suppliers
2) time needed for adjustment - consumers and firms need time to process and hear information; information gap, consumer weakness at computation

these two factors make demand inelastic in short run cuasing an initial deterioration in balance of trade following exchnage rate depreciation but the CAD will eventually fall in the long run as demand becomes more leastic with time

Question 4

effects of changes to exchange rate on:
- economic growth and employment
- inflation rate
- FDI flows

Answer 4

• eg and employment: A weaker currency can boost exports, stimulating economic growth and potentially reducing unemployment
• inflation: A depreciating currency can lead to higher import prices, contributing to inflationary pressures. Also net exports rise so AD rise = demand pull inflation
• FDI flows: Exchange rate fluctuations can affect the attractiveness of a country for FDI. A weaker currency may make a country’s assets more appealing to foreign investors. (bc now its cheaper to invest) but continued falling currency discouraging FDI

Question 5

How can government use interest rates to influence value of currency

Answer 5

a government can use interest rates.
- An increase in interest rates will strengthen the pound as people will convert their money to pounds to put them in English banks, so demand for pounds will rise. Falls in interest rates will decrease demand for the pound so weaken the currency

Question 6

How can government use gold and foreign currency resevred to manipulate value of currency

Answer 6

• If the value of the pound is too high and they want to weaken it, they can increase supply by buying foreign currency or gold with pounds. To strengthen the pound, they can increase demand by selling their foreign currency or
  gold in exchange for pounds.
• Central banks have found that this method tends to have little impact on currencies in the long term. They are also able to limit supply of
  currency by introducing currency controls, and by doing so they can fix the value of
  the currency

Question 7

What is the managed floating exchange rate

Answer 7

exchange rate system that allows a nation’s central bank to intervene regularly in foreign exchange markets to change the direction of the currency’s float and/or reduce the amount of currency volatility. This exchange rate system is also known as a “dirty float”.

Question 8

Motivation for a managed floating currency

Answer 8

• Improve the balance of trade or improve the current account by making exports more price competitive
• Reduce the risk of a deflationary recession - a lower currency increases export demand and increases the domestic price level by making imports more expensive
• Rebalance the economy away from consumption towards higher exports and capital investment

Question 9

Limite to central bank intervention for a managed exchange rate

Answer 9

• Requires large-scale foreign exchange reserves – many smaller and relatively poorer countries do not have these
• Central banks intervening on their own may have little or no market power against the sheer weight of speculative buying and selling in global currency markets (turnover > $6 trillion a day)
• Changing interest rates to influence a currency might conflict against other macroeconomic objectives - raising interest rates to support a currency might stifle growth

Question 10

simple explanation of managed exchange rate

Answer 10

Each country had a central fixed exchange rate, but with a small band of flexibility, allowing the rate to fall slightly below, or rise slightly above the central rate. If the rate threatened to go above the ‘ceiling’ or below the ‘floor’, the central bank would have to intervene by lowering/raising interest rates or selling/buying foreign currency.

In exceptional circumstances countries were allowed to devalue or revalue (for instance if a country had a large and persistent current account deficit that it could not finance), but only with the agreement of other countries in the system

Question 11

explanation of mnaged exhcnage rates in depth

Answer 11

https://studyrocket.co.uk/revision/a-level-economics-a-edexcel/a-global-perspective/exchange-rates