the global economy (4.5)

exchange rates

exchange rates

the value of one currency expressed in terms of another currency

floating exchange rate

the value of a currency is determined by the demand for and supply of the currency in the foreign exchange market

fixed exchange rate

central bank buys & sells foreign currencies to ensure the value of its currency stays at a single predetermined rate

depreciation

the loss of value of a country’s currency with respect to a foreign currency

appreciation

the increase of value of a country’s currency with respect to a foreign currency

changes in supply & demand for a currency

• foreign demand for exports

• domestic demand for imports

• inward/outward foreign direct investment

• inward/outward portfolio investment

• remittances

• speculation

• relative inflation, interest & growth rates

• central bank intervention

inward foreign direct investment

foreign multinational corporations expanding their operations in the domestic economy

outward foreign direct investment

domestic multinational corporations expanding their operations in overseas markets

inward portfolio investment

spending in the domestic economy by foreign investors

outward portfolio investement

spending by an economy’s investors in overseas markets

remittances

movement of money when nationals working abroad send money back to their home country

speculation

when a financial asset is purchased in the hope or anticipation that the resale value will be higher

consequences of change in exchange rate on economic indicators

• current account balance

• unemployment

• inflation

• economic growth

• living standards

foreign currency reserves

stocks of foreign currencies held by the central bank

devaluation

when the price of a currency operating in a fixed exchange rate system is officially and deliberately lowered

revaluation

when the price of a currency operating in a fixed exchange rate system is officially and deliberately increased

managed exchange rate

where the govt./central monetary authority intervenes periodically in the foreign exchange market to influence the exchange rate, when deemed necessary to maintain certainty & confidence in the economy

overvalued currency

when the value of a currency is above its equilibrium value in the long run

undervalued currency

when the value of a currency is below its equilibrium value in the long run

crawling peg system

method to manage a currency

involves the setting of two upper & lower bands, which the govt. strives to keep the currency value within by periodic intervention