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What are the differences between a floating exchange rate system and a fixed /
managed rate system?
• Exchange Rate
• Fixed Exchange Rate
• Devaluation and Revaluation
• Graph
Lesson • Free Floating Exchange Rate
Objective • Depreciation and appreciation
Section 4.5 • Graph
• Calculation
• Reasons of Demand and Supply
• Advantages and Disadvantages
Devaluation - when the value of a nation's currency falls, relative to other
currencies, due to a deliberate policy decision by the government or central
bank.
Revaluation - when the value of a nation's currency rises, relative to other
currencies, due to a deliberate policy decision by the government or central
Terminologie bank.
Appreciation - when the value of a nation's currency rises, relative to other
s currencies, as a result of a market forces, rather than deliberate actions of
the government or central bank.
Depreciation - when the value of a nation's currency falls, relative to other
currencies, as a result of market forces, rather than deliberate actions of the
government or central bank.
Fixed exchange rate system - an exchange rate regime applied by a
government or central bank that ties a country's official exchange rate to
another country's currency (usually the $ or Є) or the price of gold.
Managed exchange rate system - the exchange rate system employed by
many modern economies. Under this system the exchange rate is allowed
to fluctuate, but central banks will influence the exchange rates to maintain a
certain range.
Exchange Rate: the value of one currency expressed in terms of
another currency.
$1 = 30.8 L.E
Currencies are exchanged on the foreign exchange market. The market
Exchange includes:
Rate - Governments
- Central Banks
- Private Commercial Banks
- Financial Institutions
Fixed Exchange Rate: where the exchange rate is set and
maintained at some level by the government (or central
bank) of the country.
Revaluation: when the value of the currency is raised in
terms of other currencies
Fixed Devaluation: when the value of the currency is lowered in
Exchange terms of other currencies.
Rate Graphs (notebook)
Floating Exchange Rate: where the exchange rate that
the market forces are left to float without any government
or central bank intervention. It is left for the demand and
supply of the currency.
Appreciation: when the value of the currency is raised in
terms of other currencies
Floating
Exchange Depreciation: when the value of the currency is lowered in
terms of other currencies.
Rate
Appreciation of one currency towards the other, results in
depreciation.
Graphs (notebook)
1. The US dollar is cuurently trading against the euro at a
rate of $1 = 0.8E.
What is the rate of 1E to US$?
Floating 2. The exchange rate above, what would be the cost in
Exchange euros of a good that is selling for $75?
Rate 3. If the exchange rate changes from $1 = 0.8E to $1 =
Claculations 0.9E, explain what would happen to the euro price of a US-
manufactured dress shirt being exported to Europe from the
USA at $150.
Paper 2 and 3
Demand Supply
Exports to foreign countries Imports
Investment in the local country Investment in foreign countries
What causes Saving Money in local bank Saving money outside the country
shifts in the Speculation of appreciation Speculation of depreciation
Demand and Low inflation rates, so cheaper goods High inflation rate, cheaper imports
Supply of An increase in consumer income from
foreign countries might increase
Increase income, increase imports
currency tourism or exports
Increase in intrest rates, making it Low consumer confidence
Graph in the book
more attractive to save in local
cuurency
High speculation and consumer
confidence
Managed Exchange Rate: where the exchange system
there is no announced level or band but either the exchange
rate is allowed to float within some implicit upper and lower
bound and intervene only when needed.
Most exchange rates are managed exchange rates.
Managed
Exchange
Rate
Advantages Disadvantages
Downward pressure on inflation: Damage to export industries
importing raw materials will be
cheap, so cost of production will be
Advantages lower.
and More imports can be bought Damage to domestic industries
Disadvantages
High Exchange
Rate Domestic producers improve their
efficiency
Advantages
and Advantages Disadvantages
Disadvantag Greater employment in export
industries
Inflation, due to high imported goods
and services raw materials
es Low Greater employment in domestic
industries
Exchange
Rate
Why the Government intervenes:
- Lower exchange rate to increase employment
- Raise the exchange rate to fight inflation
- Maintain a fixed exchange rate
- Avoid large fluctuations
Government - Improve business confidence
- Improve current account deficit
intervention
in exchange Ways of intervention:
- Using their reserves of foreign currencies to buy, or sell
rates foreign currencies. (use reserves to buy their own
currency, this increases the demand and increases the
exchange rate)
- By changing the interest rates: by increasing interest
rates, should attract financial investment from abroad, In
order to put money the investors will have to buy the
country’s currency.
Advantages Disadvantages
Reduce uncertainty for all economic Changing interest rates to maintain a
agents fixed rate, will affect the economy,
might reduce AD, and increase
Advantages unemployment
and Help to reduce inflation, and sure Need high reserves of foreign
Disadvantages competitiveness compared to outside currencies to be able to stabilize the
market exchange rate
Fixed Exchange
Rate (HL) Reduce specualtion Very difficult to maintain it and find
the right value (and if too low, will
create economic disputes as exports
Advantages will be very cheap)
Advantages Disadvantages
and
Interest rates are not affected and Uncertainty on international markets.
Disadvantag only monetary tools are used
es Floating Could adjust itself in order to keep
the account balanced (Balance of
Do not self adjust as there are some
government intervention
Exchange Payments)
Rate (HL) No need to have a high amount of
foreign currencies.
Worsen Inflation
- Paper 1
- Explain three factors that might lead to an
increase in the demand for a currency
- Paper 2: p403
Homework
