9708 · 6.4
Exchange rates flashcards
Revision flashcards for Cambridge 9708 Exchange rates (syllabus 6.4). Flip, recall, then mark a real past-paper question.
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What is an exchange rate?
The price of one currency expressed in terms of another (e.g. £1 = $1.25).
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Floating vs fixed exchange rate?
Floating: market supply and demand set the rate. Fixed: government/central bank pegs the rate and intervenes to maintain it.
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What is currency appreciation?
The domestic currency rises in value — it buys more foreign currency. Exports become dearer abroad; imports cheaper at home.
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What is currency depreciation?
The domestic currency falls in value — it buys less foreign currency. Exports cheaper abroad; imports dearer at home.
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How does depreciation affect AD?
Cheaper exports and dearer imports raise net exports (X − M), increasing aggregate demand (ceteris paribus).
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How can a central bank support a fixed rate?
Buy its own currency (sell foreign reserves) if undervalued pressure; sell its currency (buy reserves) if overvalued pressure.
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Define 'Appreciation'.
A market-driven increase in the value of a currency in a floating exchange rate system. The currency can now purchase more of another currency. For example, the pound appreciates against the dollar if its value moves from £1 = $1.20 to £1 = $1.30.
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Define 'Devaluation'.
An official, deliberate lowering of a currency's value by the government or central bank within a fixed exchange rate system. This is a policy decision, not a market outcome.
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What is the Marshall-Lerner condition?
The condition states that a currency depreciation or devaluation will only lead to an improvement in the current account balance if the sum of the price elasticities of demand for exports and imports is greater than one (PEDx + PEDm > 1).
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What are 'hot money' flows?
Short-term, speculative capital flows that move between countries to take advantage of higher interest rates or anticipated exchange rate changes. They are a major cause of exchange rate volatility.
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How does a central bank defend a fixed exchange rate that is under pressure to fall?
It can intervene in the FOREX market by buying its own currency using its foreign currency reserves. Alternatively, it can raise domestic interest rates to attract 'hot money' inflows, which increases demand for the currency.