6.3 Foreign exchange rates

Monetary policy has changed in Ethiopia in recent years. The country\'s central bank now uses changes in the interest rate rather than controls on bank lending. It has also moved from operating a fixed exchange rate to a floating exchange rate. The Ethiopian Government uses a range of supply-side policy measures. The government has privatised some sugar processing firms, but most large firms are still state-owned.

d) Discuss whether or not having a fixed exchange rate will benefit an economy.

Nigeria has a mixed economic system. In january 2023, Nigeria had a high unemployment rate of 33% which created a number of costs. Its high inflation rate of 22% had several effects on the country's firms. In 2022 and the start of 2023, Nigerians increased their demand for foreign currency.

c) Analyse the causes of an increase in the demand for foreign currency. [6]

Jordan has a fixed foreign exchange rate with the US dollar. The monetary policy of Jordan, therefore, follows the monetary policy of the US very closely. Due to low confidence in the global economy in 2019, central banks around the world, including Jordan and the US, cut interest rates to stimulate growth. However, this may have conflicted with the macroeconomic aim of low inflation.

d) Discuss whether or not a country will benefit from having a fixed foreign exchange rate system. [8]

While 15% of US exports go to Mexico, 80% of Mexico's exports go to the US. In 2019, the US government imposed some methods of protection to reduce imports from Mexico. This US action caused a fall in Mexico's foreign exchange rate. Despite a rise in its inflation rate, Mexico's central bank reduced the rate of interest from 7.75% at the end of 2019 to 6.5% in March 2020.

c) Analyse how a fall in a country's foreign exchange rate could increase its inflation rate. [6]

Australia's foreign exchange rate fluctuates. The value of Australia's exports is regularly greater than the value of its imports. Australia is Papua New Guinea's main trading partner. In 2019, the government of Papua New Guinea increased income tax to reduce its inflation rate. It used other policy measures to increase its economic growth rate.

a) Define foreign exchange rate. [2]

The money supply in Bangladesh increased every year from 2010 to 2018. Changes in the money supply and the foreign exchange rate can affect a government's macroeconomic policy aims, including full employment. There have been few mergers between commercial banks in Bangladesh, although its banks are larger than many of its other firms.

c) Analyse how a fall in a country's foreign exchange rate could increase employment. [6]

Wage rate growth has increased recently in Kazakhstan, but its economic growth rate has slowed. This is, in part, due to a fall in exports. To try to increase the economic growth rate, the government has increased its spending on investment. In August 2015, it adopted a floating foreign exchange rate system in an attempt to improve the country's macroeconomic performance.

d) Discuss whether or not a country should switch from a fixed foreign exchange rate system to a floating foreign exchange rate system. [8]

In 2014, the government of Kazakhstan devalued its currency, the tenge. A year later the country still had a current account deficit. Therefore, in 2016 it considered adopting a floating exchange rate which might help to remove the deficit. However, it had concerns that this might affect the country's inflation rate which was already high at 17%.

a) Define devaluation. [2]

b) Explain two advantages of a floating exchange rate. [4]

In 2016, there were fears that the Singaporean economy could enter a recession because of falling demand from China, its biggest export market. One of the results of a recession is likely to be a fall in consumer spending. A previous recession in 2008 had led to unemployment increasing from 1.6% to 3.4%. Singapore's central bank therefore decided to intervene in the foreign exchange market to influence the value of the currency.

d) Discuss whether or not an exchange rate depreciation will prevent an economy from experiencing a recession. [8]

The effects of a depreciation of a currency are influenced by the price elasticity of demand of exports and imports. Worldwide there has been a reduction in trade barriers including tariffs. There has also been an increase in the movement of goods and services between countries and, to a lesser extent, the movement of people. Some countries experience net emigration with more people leaving the country than entering it.

a) Define depreciation of a currency. [2]

b) Explain two reasons why demand for a country's exports may be price-inelastic. [4]