9708 · 11.2
Exchange rates flashcards
Revision flashcards for Cambridge 9708 Exchange rates (syllabus 11.2). Flip, recall, then mark a real past-paper question.
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Floating vs fixed exchange rate?
Floating: market forces set rate. Fixed: central bank pegs to another currency/gold, intervenes to maintain peg.
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Depreciation effects?
Exports cheaper abroad, imports dearer at home → ↑X, ↓M; may cause cost-push inflation.
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Appreciation effects?
Exports dearer, imports cheaper → ↓X, ↑M; reduces import-price inflation but hurts exporters.
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Purchasing power parity (PPP)?
Long-run tendency for exchange rates to adjust so identical goods cost the same internationally — Big Mac index illustration.
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Impossible trinity (trilemma)?
Cannot simultaneously have fixed exchange rate, free capital movement, AND independent monetary policy — must choose two.
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Managed float?
Rate mainly market-determined but central bank intervenes to smooth volatility or target bands — hybrid system.
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What is the J-Curve effect?
It illustrates how a currency depreciation initially worsens the current account balance (due to inelastic demand) before improving it in the long run as demand for exports and imports becomes more elastic.
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State the Marshall-Lerner condition.
For a currency depreciation to improve the current account, the sum of the price elasticity of demand for exports and the price elasticity of demand for imports must be greater than one (PEDx + PEDm > 1).
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What is Purchasing Power Parity (PPP) theory?
A long-run theory that an exchange rate will adjust to equalise the price of a basket of goods between countries. Relative PPP suggests exchange rate changes reflect inflation differentials.
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What is a managed float exchange rate system?
A system where the exchange rate is determined by market forces, but the central bank intervenes by buying or selling currency to influence its value, aiming to reduce volatility or meet policy goals.
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What are the main consequences of a sustained currency appreciation?
It leads to cheaper imports (reducing cost-push inflation) but more expensive exports (harming export competitiveness and potentially worsening the current account). It can also reduce the domestic value of foreign debt.