Advantages and disadvantages of floating exchange rates
Syllabus: Evaluate the possible economic consequences of a change in the value of a currency, including the effects on a country’s- inflation rate,
- employment,
- economic growth and
- current account balance.
Governments can use exchange rates to
affect economic performance. An appreciating exchange rate, which is
often linked to an increase in base interest rates (SELIC in Brazil),
leads to exports becoming more expensive, but imports falling in price
(So you can use AD/AS analysis to show what would happen to inflation
and/or unemployment and economic growth).
This reduces part of the
inflationary pressure within an economy. A fall in the exchange rate
will lead to the reverse and may help domestic businesses export more
but could be inflationary - can you explain why?
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Sterling sinks to a near seven-year low against the US dollar after Boris Johnson fails to back David Cameron's EU reform deal.
19:45, UK,Monday 22 February 2016
The pound has fallen sharply after a series of political heavyweights threw their weight behind a UK exit from the European Union.
Sterling dropped by up to 3% during the day, touching a near seven-year low against the US dollar, at times nearing $1.40. It has not seen such lows since March 2009.
It regained some ground later on but the falls gave the pound its steepest one-day decline versus the US currency since early 2009 at the height of the recession.
It was also down by three-quarters of a cent against the euro - at times brushing its lowest level in more than a year - after London mayor Boris Johnson and a number of Cabinet ministers said they wanted to leave Europe.
A weaker pound against the single currency makes breaks to European destinations such as the Costa del Sol more expensive for UK holidaymakers - at a time when many will be preparing for their Easter getaways.
Falls against the dollar, the world's most important currency, will be reflected in the cost of travel elsewhere in the world.
But the decline in the pound is good news for British exporters because it makes their goods cheaper in foreign markets - with manufacturers having struggled because of the strength of sterling in recent months.
The fall came after an EU reform deal reached by Prime Minister David Cameron ahead of an in-out referendum on 23 June that failed to satisfy his eurosceptic critics.
US bank Citi said it estimated the chances of Britain leaving the European Union had risen to 30-40% from 20-30%.
Citi's UK economist Michael Saunders said: "The effects of Brexit, if it happens, are likely to be large and painful in economic and political terms, both for the UK and the overall EU."
Alvin Tan, a strategist with Societe Generale, said: "The out camp were struggling to get a figurehead who was popular and Boris has given them that boost.
"There is genuine worry that Britain might vote to leave and the uncertainty is going to rise into the referendum."
However, Mr Cameron looks set to win the backing of dozens of FTSE 100 listed companies which are preparing to issue a warning on the threat to investment and jobs should the UK leave Europe.
Meanwhile two polls by business groups showed a majority of firms backing continued membership.
In stocks, the FTSE 100 Index looked untroubled by the latest developments, and closed above the 6,000-mark following turbulence in recent weeks.
A broker note from JP Morgan upgraded UK shares, judging that Britain would choose to stay in the European Union and that even it did leave, the fall in the pound and likely action from the Bank of England would cushion the impact.
However, house building shares were lower, with Berkeley Group down 5% and Barratt Developments off by 4%.
A note last month from analysts at Credit Suisse suggested a fall in immigration as a result of Brexit could cut housing demand.
Question 1
Define Depreciation (2 marks)Question 2
Using a diagram, explain why the currency depreciated following the bad news. (4 marks)
Question 3
A broker said about Britain `that
even it did leave, the fall in the pound and likely action from the
Bank of England would cushion the impact.ī (third from last paragraph)
discuss whether you agree with this statement, now that Britain has
left the EU. (8 Marks)
