Hey there! Sign in to join this conversationNew here? Join for free
    • Thread Starter
    Offline

    0
    ReputationRep:
    Hello, I'm concerned with a few things from the syllabus that I can't understand, regardless of the help from Khan Accademy, my book and other sources.I cannot understand the following

    • How does the exchange rate affect inflation?
    • How does inflation affect the exchange rate?
    • What relationship does the balance of payments have on inflation?
    • How do interest rates help with controlling the exchange rate?
    • What does a high exchange rate mean for a country

    Any answers to the following will be much appreciated. Thankyou
    Offline

    16
    ReputationRep:
    I recommend you post this in the relevant subject thread, more people will see it who can help


    Posted from TSR Mobile
    Offline

    2
    ReputationRep:
    (Original post by jacobcraft)
    Hello, I'm concerned with a few things from the syllabus that I can't understand, regardless of the help from Khan Accademy, my book and other sources.I cannot understand the following

    • How does the exchange rate affect inflation?
    • How does inflation affect the exchange rate?
    • What relationship does the balance of payments have on inflation?
    • How do interest rates help with controlling the exchange rate?
    • What does a high exchange rate mean for a country

    Any answers to the following will be much appreciated. Thankyou
    How does the exchange rate affect inflation? It does not have any impact. Its the other way around. Interest rate affects exchange rate.

    If the level of interest rate is too high then this will attract foreigners to invest in UK we call this FDI. When interest rates are high these foreigners are demanding more £££ in order to invest. As demand rises so does the value of £££.

    What relationship does the balance of payments have on inflation? If the levels of inflation are high for whatever reasons then this makes that country less internationally competitive. If your prices are high then your exports are likely to fall and imports are likely to fall. Although this depends on a lot of other things such as the price elasticity of net exports.

    How do interest rates help with controlling the exchange rate? I think I've kind of answered that with the first to questions.

    What does a high exchange rate mean for a country? High exchange rate means that exports will become expensive for foreigner and imports will become cheaper for domestic citizens and this COULD lead to a current account deficit.
    Offline

    0
    ReputationRep:
    Exchange rate can affect inflation. If the exchange rate appreciates by 10% and the country is open and a net importer then prices domestically will fall. It's called exchange rate pass through.

    If inflation is high and is expected to remain high then investors will be skeptical about holding money domestically as its relative value will be expected to fall over time. Money flows out of the country and the exchange rate depreciates.

    Just apply the last paragraph for the effect of inflation on the exchange rate and hence bop.

    Interest rates attract investors and hence push up the value of the domestic currency. You can say over time for a no arbitrage condition to hold that if the country is small then if interest rates are higher than the rest of the world the currency will be expected to fall in value over time...this is UIP. However you could just stick with the very short run.

    As the person above has emphasised the overall effect of a changing exchange rate depends on the elasticities of net exports. If the sum of export and import elasticities is greater than one then we will get an improvement in the current account following a depreciation.

    I hope this helps.
    Offline

    2
    ReputationRep:
    (Original post by mattdns163)
    Exchange rate can affect inflation. If the exchange rate appreciates by 10% and the country is open and a net importer then prices domestically will fall. It's called exchange rate pass through.

    If inflation is high and is expected to remain high then investors will be skeptical about holding money domestically as its relative value will be expected to fall over time. Money flows out of the country and the exchange rate depreciates.

    Just apply the last paragraph for the effect of inflation on the exchange rate and hence bop.

    Interest rates attract investors and hence push up the value of the domestic currency. You can say over time for a no arbitrage condition to hold that if the country is small then if interest rates are higher than the rest of the world the currency will be expected to fall in value over time...this is UIP. However you could just stick with the very short run.

    As the person above has emphasised the overall effect of a changing exchange rate depends on the elasticities of net exports. If the sum of export and import elasticities is greater than one then we will get an improvement in the current account following a depreciation.

    I hope this helps.
    Hmm very interesting.....
    Could the government fix this through protectionist acts such as tariffs and quotas?
    Offline

    0
    ReputationRep:
    (Original post by dan94adibi)
    Hmm very interesting.....
    Could the government fix this through protectionist acts such as tariffs and quotas?
    Yes I suppose so. But could say in the short to medium term it's not a problem as prices are sticky and exchange rate changes are so volatile. Only if the exchange rate is expected to appreciate in the long run then it may be more effective. I believe tariffs are really only beneficial for infant industries in the long run though. You can just combat low prices through monetary policy.
    Offline

    2
    ReputationRep:
    (Original post by jacobcraft)
    Hello, I'm concerned with a few things from the syllabus that I can't understand, regardless of the help from Khan Accademy, my book and other sources.I cannot understand the following

    • How does the exchange rate affect inflation?
    • How does inflation affect the exchange rate?
    • What relationship does the balance of payments have on inflation?
    • How do interest rates help with controlling the exchange rate?
    • What does a high exchange rate mean for a country

    Any answers to the following will be much appreciated. Thankyou

    1&2)Inflation actually affects exchange rates, as increase in inflation due to Demand Pull or Cost push causes price level to increase. This makes the Pound more expensive, this will make exports(X) more expensive to foreigners as they pay more per pound for same unit. Imports (M) increase as they are relatively cheaper and if it is Demand pull inflation (shift in AD) then disposable incomes have also increased as the UK has a strong Marginal Propensity to Import (MPM), Imports will increase significantly with increase in Income.

    3) Increase in Inflation, Increase M and decrease X. This will deteriorate the Balance Of Payments as the BoP is X-M. This worsens the Current Account Deficit. This depends on magnitude in increase of inflation and depends on elasticity of X & M.

    4)The MPC Manipulate Interest Rate (IR) to control Inflation, and inflation affects X & M which are in effect the main use of exchange rates. So if exports are low and imports are high the MPC can increase IR which causes consumption to decrease as cost of borrowing has increased (harder to get loans etc) which shifts AD inwards. Lowering Price Level and therefore making exports cheaper (increase) and imports more expensive(decrease).

    5) A high Exchange rate means that Exports will be low and imports will be high. The BoP will deteriorate as less exports into a country, and imports will be high but AD= C+I+G+(X-M) so the price mechanism will cause AD to shift to the left and the Pound will get weaker. So the effect will be short term.
    Offline

    2
    ReputationRep:
    (Original post by mattdns163)
    Yes I suppose so. But could say in the short to medium term it's not a problem as prices are sticky and exchange rate changes are so volatile. Only if the exchange rate is expected to appreciate in the long run then it may be more effective. I believe tariffs are really only beneficial for infant industries in the long run though. You can just combat low prices through monetary policy.
    Cheers for the answer.
 
 
 
Poll
Do you agree with the PM's proposal to cut tuition fees for some courses?

The Student Room, Get Revising and Marked by Teachers are trading names of The Student Room Group Ltd.

Register Number: 04666380 (England and Wales), VAT No. 806 8067 22 Registered Office: International House, Queens Road, Brighton, BN1 3XE

Write a reply...
Reply
Hide
Reputation gems: You get these gems as you gain rep from other members for making good contributions and giving helpful advice.