kooltrainer said:
a) distinguish between flexible peg and fixed exchange rate
b) Outline at least 2 risks of having a fixed exchange rate
c) would $A appreciate/depreciate if there was a rise in interest rates overseas? explain.
d) Briefly explain how balance of payments influence the exchange rate
thx
Havn't done this stuff in a while, if im wrong someone can correct me.
a) Managed flexible peg is where a central bank, or RBA in australia sort of manage the exchange rate by acting in the money market at 9am each morning to help manage the exchange rate. Whereas a fixed exchange rate is where the central bank or RBA in australia just sets an exchange rate with no intervention at all from market forces.
b) Problems or risks are ones associated with having either a over-valuded or under-valuded currency. cbf explaining.
c) If there is a rise of interest rates overseas relative to australian interest rates the australian dollar would depreciate as australian investors would invest in that country as they would earn higher return on their capital, this would result in a increase in demand for this foriegn dollar. To me, this whole concept it pretty much only theoretical as people wouldn't invest there money in an overseas country to actually make money unless the interest rates where extremely high on comparision, but this would only mean instable inflation which is a no-go and would detract investor confidence making the whole concept stupid. Like you arn't going to put your money in another country if interest rates go up 25 basis ponits in sadi arabia.
d) This whole concept is pretty advanced.
Simply, under a floating exchange rate such as australia, the quantity supplied of aussie bucks must equal the quantity demanded, as there has to be equilibrium. This relates to the BOP as money coming out of australia or the supply of aussie dollars on the Current account has to equal the money coming into australia or the demand for aussie dollars on the capital and financial account.
So if the BOP don't balance then the exchange rate will equalise to make it balance.
because remember: CA + capital and financial account + statisitical errors and ommisions = 0.
