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Exchange Rate
 The price of a nation’s currency in terms 
of another currency. 
 An exchange rate thus has two 
components, the domestic currency and 
a foreign currency. 
 For example our domestic currency is the 
Jamaican Dollars (JMD) and the Foreign 
Currency can be United States Dollars 
(USD) or Euros (EUR) just to name a few.
We will be exploring three types of 
Exchange Rates which are: 
1. Fixed Exchange Rate 
2. Floating/Flexible Exchange Rate 
3. Managed Float
 This is where a Government maintains a 
given exchange rate over a period of 
time. 
 This could be for a few months or even 
years. 
 In order to maintain the exchange rate 
at the stated level government uses 
fiscal and monetary policies to control 
aggregate demand.
 In a fixed exchange rate system the XR is 
set by the government or central bank 
at a particular rate. 
 E.g. BBD to US 2:1. 
 The forces of supply and demand do not 
determine the rate. The central bank 
holds reserves of US dollars and 
intervenes in order to keep the 
exchange rate pegged at that level 
known as the Official Rate.
Exchange Rate
1. The risk and uncertainty of trade and 
promoting foreign direct investment (FDI) is 
reduced thus making business and 
investment planning possible. 
2. Reduced Currency Speculation. 
3. Creates a stability in knowing the 
exchange rate
1. Protecting the exchange rate requires 
domestic economic policies to be 
frequently adjusted. Monetary policy 
focuses on keeping the rate stable. 
2. Reserves are needed to protect the value. 
3. An improvement in an economy’s 
competiveness that results in lower prices 
will not be fully passed on to export 
customers if the exchange rate remains 
unchanged. 
4. Exchange rate may be undervalued or 
overvalued.
 A floating exchange rate regime is 
where the rate of exchange is 
determined purely by the demand and 
supply of that currency on the foreign 
exchange market.
 The value of a currency is allowed to be 
determined by the forces of demand 
and supply on the foreign exchange 
market. 
 There is no government intervention.
 Any change in supply or demand for a 
currency will cause a depreciation or 
appreciation in the exchange rate. 
 An increase in demand for the local 
currency causes it to appreciate or rise. 
 However, if there is a greater demand 
for the foreign currency the value of the 
local currency falls or depreciates to the 
foreign currency.
Do not 
Pay 
attention 
to the 
current 
xrate as 
this was 
way back 
in 1999 
and just 
an 
example
 An appreciation means an increase in the 
value of a currency. It means a currency is 
worth more in terms of foreign currency. 
 A rise or appreciation in the economy in the 
country’s currency will mean that the price 
of imports into the country will fall and the 
price of the country’s exports will rise. 
 This is represented by a shift in the supply 
curve to the left.
Do not 
Pay 
attention 
to the 
current 
xrate as 
this was 
way back 
in 1999 
and just 
an 
example
 This could be caused by: 
1. A decrease in the number of foreign 
goods and services imported into the 
economy. 
2. A decrease in the number of the 
economy’s investors who want to place 
their funds in foreign economies.
1. Exports more expensive. The foreign 
price of Ja Exports will increase and US 
will find Ja exports more expensive. 
Therefore with a higher price, we would 
expect to see a fall in the quantity of Ja 
exports. 
2. Imports are cheaper. Ja consumers will 
find that JA$1 now buys a greater 
quantity of US goods. Therefore, with 
cheaper imports we would expect to 
see an increase in the quantity of 
imports.
3. Lower (X-M) With lower exports, higher 
demand and greater spending on imports, 
we would expect a fall in domestic 
Aggregate Demand (AD), causing lower 
economic growth. 
4. Lower inflation. An appreciation tends to 
cause lower inflation because: 
1. import prices are cheaper. The cost of 
imported goods and raw materials will fall after 
an appreciation, e.g. imported oil will 
decrease, leading to cheaper petrol prices. 
2. Lower AD leads to lower demand pull inflation. 
3. With export prices being more expensive 
manufacturers will have greater incentives to 
cut costs to try and remain competitive.
 A depreciation means a decrease in the 
value of a currency. It means a currency is 
worth less in terms of a foreign currency. 
 A fall or depreciation in the value of the 
exchange rate will mean the opposite, that 
is the price of imports into the country will 
rise and the price of the country’s export 
will fall. 
 This is represented by a shift of the demand 
curve to the left.
Do not 
Pay 
attention 
to the 
current 
xrate as 
this was 
way back 
in 1999 
and just 
an 
example
 This could be caused by: 
1. A reduction in the number of the 
economy’s goods and services sold 
abroad. 
2. A reduction in the number of 
international investors who wish to place 
their funds in the economy.
1. Exports cheaper. A devaluation of the 
exchange rate will make exports more 
competitive and appear cheaper to 
foreigners. This will increase demand for 
exports 
2. Imports more expensive. A devaluation 
means imports will become more 
expensive. This will reduce demand for 
imports. 
3. Increased AD. Devaluation could cause 
higher economic growth. Part of AD is (X-M) 
therefore higher exports and lower imports 
should increase AD (assuming demand is 
relatively elastic). Higher AD is likely to 
cause higher Real GDP and inflation.
4. Inflation is likely to occur because: 
 Imports are more expensive causing cost 
push inflation. 
 AD is increasing causing demand pull 
inflation 
 With exports becoming cheaper 
manufacturers may have less incentive to 
cut costs and become more efficient. 
Therefore over time, costs may increase. 
5. Improvement in the current account. With 
exports more competitive and imports more 
expensive, we should see higher exports 
and lower imports, which will reduce the 
current account deficit.
 market determined, so it is more efficient 
 no need for reserves to intervene 
 exchange rate would reflect its true 
value 
 absorbs economic shocks better 
 freedom of government to pursue 
internal policies 
 Automatic BOP adjustment, less 
likelihood of a BOP crisis
 large depreciation may occur 
 instability of exchange has a negative 
impact on domestic economy 
 terms of trade may decline with fall in 
exchange rate 
 Uncertainty of currency 
 Speculation of currency 
 reduced investment as this would be too 
risky
 The Fixed exchange rate is the rate which is 
officially fixed in terms of gold or any other 
currency by the government. It does not 
change with change in demand and 
supply of foreign currency. 
 As against it, flexible exchange rate is the 
rate which, like price of a commodity, is 
determined by forces of demand and 
supply in the foreign exchange market. It 
changes according to change in demand 
and supply of foreign currency. There is no 
government intervention.
 This is where the currency is broadly 
managed by the forces of demand and 
supply but the government takes action 
to influence the rate of change in the 
exchange rate.
 The Central Bank seeks to stabilize the 
exchange rate within a predetermined 
range for a given period of time, but 
DOES NOT FIX IT at any particular level. 
This allows for policy makers the benefit 
of planning with some degree of 
certainty, for the macroeconomic affairs 
of a country. 
 Central bank intervenes to smoothen out 
ups and downs in the exchange rate of 
home currency to its own advantage.
Exchange Rate
 The managed float attempts to combine 
the advantages of both the fixed and 
flexible exchange rate systems, 
depending on the degree of instability. 
 The less instability, the less intervention is 
necessary by central banks and they 
can pursue quasi-independent domestic 
monetary policies to stabilize their own 
economies.
 The greater the instability, the more 
intervention is necessary by central 
banks and the less free they are to 
pursue independent domestic monetary 
policies because they are frequently 
required to use their money supplies to 
calm disturbances in the foreign 
exchange markets.
 The big problem with a managed float 
comes in determining the timing and 
magnitude of the instability and the 
necessary intervention. Does a one day 
drop (rise) in a currency warrant 
intervention? A week? A month? A year? 
Five years? Is a 1% drop (rise) in a 
currency's exchange rate destabilizing? 
A 2% change? A 5% change? A 10% 
change?
 If the central banks are too quick to 
respond or if the amount of intervention 
is inappropriate, their actions may be 
further destabilizing. This increased 
instability has a tendency to dampen 
international flows and contract world 
trade. If they wait too long, permanent 
damage may be done to some 
countries' trade and investment 
balances.
 Changes in the exchange rate will cause 
an Appreciation or Depreciation in the 
local currency as explained earlier. 
 If the currency is devalued then: 
1. The price effect – goods become cheaper 
and imports become more expensive. The 
devaluation worsens the BOP. 
2. the volume effect – cheaper exports mean 
that more will be sold and less imports will 
be bought thus improving the BOP.
 The devaluation worsens the current 
account balance initially, and then it 
improves. Reasons being: 
 Time lag in consumer response – 
people may still want the expensive 
good. Consumers may be concerned 
about the quality and quantity of the 
local good and may continue buying 
the foreign goods in the short-run. 
 Time lag in producer response – 
producers may take a long time to 
adapt to say changing their plant size 
to accommodate the increase in 
demand.
THE END

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Exchange Rate

  • 2.  The price of a nation’s currency in terms of another currency.  An exchange rate thus has two components, the domestic currency and a foreign currency.  For example our domestic currency is the Jamaican Dollars (JMD) and the Foreign Currency can be United States Dollars (USD) or Euros (EUR) just to name a few.
  • 3. We will be exploring three types of Exchange Rates which are: 1. Fixed Exchange Rate 2. Floating/Flexible Exchange Rate 3. Managed Float
  • 4.  This is where a Government maintains a given exchange rate over a period of time.  This could be for a few months or even years.  In order to maintain the exchange rate at the stated level government uses fiscal and monetary policies to control aggregate demand.
  • 5.  In a fixed exchange rate system the XR is set by the government or central bank at a particular rate.  E.g. BBD to US 2:1.  The forces of supply and demand do not determine the rate. The central bank holds reserves of US dollars and intervenes in order to keep the exchange rate pegged at that level known as the Official Rate.
  • 7. 1. The risk and uncertainty of trade and promoting foreign direct investment (FDI) is reduced thus making business and investment planning possible. 2. Reduced Currency Speculation. 3. Creates a stability in knowing the exchange rate
  • 8. 1. Protecting the exchange rate requires domestic economic policies to be frequently adjusted. Monetary policy focuses on keeping the rate stable. 2. Reserves are needed to protect the value. 3. An improvement in an economy’s competiveness that results in lower prices will not be fully passed on to export customers if the exchange rate remains unchanged. 4. Exchange rate may be undervalued or overvalued.
  • 9.  A floating exchange rate regime is where the rate of exchange is determined purely by the demand and supply of that currency on the foreign exchange market.
  • 10.  The value of a currency is allowed to be determined by the forces of demand and supply on the foreign exchange market.  There is no government intervention.
  • 11.  Any change in supply or demand for a currency will cause a depreciation or appreciation in the exchange rate.  An increase in demand for the local currency causes it to appreciate or rise.  However, if there is a greater demand for the foreign currency the value of the local currency falls or depreciates to the foreign currency.
  • 12. Do not Pay attention to the current xrate as this was way back in 1999 and just an example
  • 13.  An appreciation means an increase in the value of a currency. It means a currency is worth more in terms of foreign currency.  A rise or appreciation in the economy in the country’s currency will mean that the price of imports into the country will fall and the price of the country’s exports will rise.  This is represented by a shift in the supply curve to the left.
  • 14. Do not Pay attention to the current xrate as this was way back in 1999 and just an example
  • 15.  This could be caused by: 1. A decrease in the number of foreign goods and services imported into the economy. 2. A decrease in the number of the economy’s investors who want to place their funds in foreign economies.
  • 16. 1. Exports more expensive. The foreign price of Ja Exports will increase and US will find Ja exports more expensive. Therefore with a higher price, we would expect to see a fall in the quantity of Ja exports. 2. Imports are cheaper. Ja consumers will find that JA$1 now buys a greater quantity of US goods. Therefore, with cheaper imports we would expect to see an increase in the quantity of imports.
  • 17. 3. Lower (X-M) With lower exports, higher demand and greater spending on imports, we would expect a fall in domestic Aggregate Demand (AD), causing lower economic growth. 4. Lower inflation. An appreciation tends to cause lower inflation because: 1. import prices are cheaper. The cost of imported goods and raw materials will fall after an appreciation, e.g. imported oil will decrease, leading to cheaper petrol prices. 2. Lower AD leads to lower demand pull inflation. 3. With export prices being more expensive manufacturers will have greater incentives to cut costs to try and remain competitive.
  • 18.  A depreciation means a decrease in the value of a currency. It means a currency is worth less in terms of a foreign currency.  A fall or depreciation in the value of the exchange rate will mean the opposite, that is the price of imports into the country will rise and the price of the country’s export will fall.  This is represented by a shift of the demand curve to the left.
  • 19. Do not Pay attention to the current xrate as this was way back in 1999 and just an example
  • 20.  This could be caused by: 1. A reduction in the number of the economy’s goods and services sold abroad. 2. A reduction in the number of international investors who wish to place their funds in the economy.
  • 21. 1. Exports cheaper. A devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports 2. Imports more expensive. A devaluation means imports will become more expensive. This will reduce demand for imports. 3. Increased AD. Devaluation could cause higher economic growth. Part of AD is (X-M) therefore higher exports and lower imports should increase AD (assuming demand is relatively elastic). Higher AD is likely to cause higher Real GDP and inflation.
  • 22. 4. Inflation is likely to occur because:  Imports are more expensive causing cost push inflation.  AD is increasing causing demand pull inflation  With exports becoming cheaper manufacturers may have less incentive to cut costs and become more efficient. Therefore over time, costs may increase. 5. Improvement in the current account. With exports more competitive and imports more expensive, we should see higher exports and lower imports, which will reduce the current account deficit.
  • 23.  market determined, so it is more efficient  no need for reserves to intervene  exchange rate would reflect its true value  absorbs economic shocks better  freedom of government to pursue internal policies  Automatic BOP adjustment, less likelihood of a BOP crisis
  • 24.  large depreciation may occur  instability of exchange has a negative impact on domestic economy  terms of trade may decline with fall in exchange rate  Uncertainty of currency  Speculation of currency  reduced investment as this would be too risky
  • 25.  The Fixed exchange rate is the rate which is officially fixed in terms of gold or any other currency by the government. It does not change with change in demand and supply of foreign currency.  As against it, flexible exchange rate is the rate which, like price of a commodity, is determined by forces of demand and supply in the foreign exchange market. It changes according to change in demand and supply of foreign currency. There is no government intervention.
  • 26.  This is where the currency is broadly managed by the forces of demand and supply but the government takes action to influence the rate of change in the exchange rate.
  • 27.  The Central Bank seeks to stabilize the exchange rate within a predetermined range for a given period of time, but DOES NOT FIX IT at any particular level. This allows for policy makers the benefit of planning with some degree of certainty, for the macroeconomic affairs of a country.  Central bank intervenes to smoothen out ups and downs in the exchange rate of home currency to its own advantage.
  • 29.  The managed float attempts to combine the advantages of both the fixed and flexible exchange rate systems, depending on the degree of instability.  The less instability, the less intervention is necessary by central banks and they can pursue quasi-independent domestic monetary policies to stabilize their own economies.
  • 30.  The greater the instability, the more intervention is necessary by central banks and the less free they are to pursue independent domestic monetary policies because they are frequently required to use their money supplies to calm disturbances in the foreign exchange markets.
  • 31.  The big problem with a managed float comes in determining the timing and magnitude of the instability and the necessary intervention. Does a one day drop (rise) in a currency warrant intervention? A week? A month? A year? Five years? Is a 1% drop (rise) in a currency's exchange rate destabilizing? A 2% change? A 5% change? A 10% change?
  • 32.  If the central banks are too quick to respond or if the amount of intervention is inappropriate, their actions may be further destabilizing. This increased instability has a tendency to dampen international flows and contract world trade. If they wait too long, permanent damage may be done to some countries' trade and investment balances.
  • 33.  Changes in the exchange rate will cause an Appreciation or Depreciation in the local currency as explained earlier.  If the currency is devalued then: 1. The price effect – goods become cheaper and imports become more expensive. The devaluation worsens the BOP. 2. the volume effect – cheaper exports mean that more will be sold and less imports will be bought thus improving the BOP.
  • 34.  The devaluation worsens the current account balance initially, and then it improves. Reasons being:  Time lag in consumer response – people may still want the expensive good. Consumers may be concerned about the quality and quantity of the local good and may continue buying the foreign goods in the short-run.  Time lag in producer response – producers may take a long time to adapt to say changing their plant size to accommodate the increase in demand.