<4.5 EXCHANGE RATES>

DEFINITION: EXCHANGE RATE

The EXCHANGE RATE refers to THE PRICE OF ONE CURRENCY IN TERMS OF ANOTHER. E.g. The price of 1 SGD in terms of USD is $0.74.

--FLOATING SYSTEM--

--DEFINITION: FLOATING X-RATE SYSTEM--

In a FREELY FLOATING exchange rate system (or flexible exchange rate system), EXCHANGE RATES ARE DETERMINED BY MARKET FORCES (or THE FORCES OF DEMAND and SUPPLY).
When forces RAISE the price of SGD in terms of USD, we say that the SGD is APPRECIATING or STRENGTHENING AGAINST the USD and when forces LOWER the price of SGD in terms of USD, we say that the SGD is DEPRECIATING or WEAKENING AGAINST the USD.

--DEMAND FOR USD CREATES A SUPPLY OF SGD--

WHEN SGD HOLDERS WISH TO PURCHASE SOMETHING PRICED IN USD, they will need to exchange it in the foreign exchange market.
In doing so they simultaneously INCREASE THE SUPPLY OF SGD (Causing a RIGHTWARD SHIFT in the SGD SUPPLY CURVE, resulting in a DEPRECIATION OF THE SGD),...
...and an INCREASE IN THE DEMAND FOR USD, (Causing a RIGHTWARD SHIFT in the USD DEMAND CURVE resulting in an APPRECIATION OF THE USD)

--TASK--

USING THE ABOVE EXAMPLE AS THE TEMPLATE, SHOW HOW A 'DEMAND FOR SGD CREATES A SUPPLY OF USD'

--TASK--

Draw TWO EX-RATE DIAGRAMS, one showing the exchange rate for one USD in terms of your currency and one showing the exchange rate for one unit of your currency in terms of the USD. e.g. the price of ONE SGD in terms of USD is currently THIS, while the price of ONE USD in terms of SGD is currently THIS
Now assume that AN INCREASE IN THE DEMAND FOR USD CAUSES THE PRICE OF THE USD in terms of your currency to APPRECIATE by 10%, can you SHOW/WORK OUT THE DEPRECIATION in the price of your currency in terms of the USD as a result?

--FACTORS AFFECTING DEMAND--

--EXPORT-RELATED--

--FOREIGN DEMAND FOR EXPORTS OF G & S--

WHEN FOREIGNERS (USD HOLDERS) WANT TO BUY 'MADE IN SINGAPORE' GOODS & SERVICES, they will need to DEMAND THE SGD IN EXCHANGE FOR THEIR USD.
This inevitably creates an INCREASE IN THE DEMAND FOR SGD, and an INCREASE IN THE SUPPLY OF USD.
This results in the SGD APPRECIATING against the USD, while the USD DEPRECIATES against the SGD.

--RELATIVE INFLATION RATES--

IF THE INFLATION RATE IN SINGAPORE IS LOWER THAN THE INFLATION RATE IN THE US, it would imply that SUBSTITUTABLE GOODS & SERVICES 'MADE IN SINGAPORE', ARE RELATIVELY CHEAPER THAN THEIR 'MADE IN THE US' ALTERNATIVES.
Thus SINGAPORE GOODS & SERVICES WILL BE MORE COMPETITIVELY PRICED, meaning MORE will be DEMANDED leading to an INCREASE IN THE DEMAND FOR SGD (And an APPRECIATION of the SGD) and a subsequent INCREASE IN THE SUPPLY OF USD. (Causing a DEPRECIATION of the USD)

--RELATIVE GROWTH RATES--

If one of SINGAPORE'S REGULAR TRADING PARTNERS' (THE US) EXPERIENCES RELATIVELY HIGHER LEVELS OF ECONOMIC GROWTH, then it is likely to LEAD TO A GREATER DEMAND FOR SINGAPORE'S EXPORTS (RELATIVE TO INCREASED IMPORT DEMAND).
Hence there would be an overall INCREASE IN DEMAND FOR SGD (And an APPRECIATION of the SGD) and a subsequent INCREASE IN THE SUPPLY OF USD. (Causing a DEPRECIATION of the USD), and vice versa if the US suffered a recession.

--INVESTMENT-RELATED--

--INWARD FDI & PORTFOLIO INVESTMENT--

If a US MNC WISHES TO INVEST IN PRODUCTION FACILITIES IN SINGAPORE [FDI], or indeed FOREIGNERS WISH TO BUY FINANCIAL INVESTMENTS SUCH AS BONDS AND SHARES IN SINGAPORE COMPANIES then they will require SGD.
Hence greater levels of FDI and investment in Singapore, will result in an INCREASE IN DEMAND FOR SGD (And an APPRECIATION of the SGD) and a subsequent INCREASE IN THE SUPPLY OF USD. (Causing a DEPRECIATION of the USD), and vice versa.

--RELATIVE INTEREST RATES--

BONDS and SAVINGS are one of the MAIN FINANCIAL INSTRUMENTS used by investors to GAIN A RETURN ON THEIR MONEY
Therefore IF SAVING AND BONDS IN SINGAPORE YIELD A GREATER REWARD IN TERMD OF INTEREST EARNED RELATIVE TO THE US, then there will likely be an INCREASE IN DEMAND FOR SGD (And an APPRECIATION of the SGD) and a subsequent INCREASE IN THE SUPPLY OF USD causing a DEPRECIATION of the USD), and vice versa.

--OTHER FACTORS--

--LEVEL OF INWARD REMITTANCES--

TRANSFERS refer to PAYMENTS FROM ONE COUNTRY, THAT DO NOT RECEIVE A GOOD OR SERVICE IN RETURN.
In most cases, these come in the form of REMITTANCES which are EARNINGS SENT BY FOREIGN WORKERS TO FAMILY MEMBERS BACK IN THEIR HOME COUNTRIES.
If REMITTANCES FROM THE US TO SINGAPORE INCREASED then there would be an INCREASE IN DEMAND FOR SGD (And an APPRECIATION of the SGD) as would the SUPPLY OF USD (Leading to a DEPRECIATION of the USD).

--SPECULATION (APPRECIATION)--

If CURRENCY SPECULATORS EXPECT THE SGD TO APPRECIATE, THEY WILL SEEK TO BUY SGD NOW, in the hope of SELLING IT LATER AFTER ITS VALUE INCREASES, thereby MAKING A PROFIT. However, as they buy the currency THE DEMAND FOR SGD INCREASES causing it to appreciate; there is, therefore, a self-fulfilling prophecy at work.

--CENTRAL BANK INTERVENTION--

EVERY CENTRAL BANK HOLDS FOREIGN EXCHANGE RESERVES that they sometimes buy or sell in order to INFLUENCE THE VALUE OF THE DOMESTIC CURRENCY.
IF THE CENTRAL BANK WISHES TO INCREASE THE DEMAND FOR ITS CURRENCY, IT WILL SELL SOME OF ITS FOREIGN CURRENCY.
In doing so THE DEMAND FOR SGD INCREASES causing it to APPRECIATE.

--FACTORS AFFECTING SUPPLY--

--IMPORT-RELATED--

--DOMESTIC DEMAND FOR IMPORTS OF G & S--

WHEN SINGAPOREANS (SGD HOLDERS) WANT TO BUY MORE 'MADE IN THE USA' GOODS & SERVICES, they will need to DEMAND MORE USD AND EXCHANGE MORE SGD.
This inevitably creates an INCREASE IN THE SUPPLY OF SGD and an INCREASE IN THE DEMAND FOR USD.
This results in the SGD DEPRECIATING against the USD, while the USD APPRECIATES against the SGD.
And vice versa..

--RELATIVE RATE OF INFLATION--

IF THE INFLATION RATE IN SINGAPORE IS HIGHER THAN THE INFLATION RATE IN THE US, it would imply that SUBSTITUTABLE GOODS & SERVICES 'MADE IN SINGAPORE', ARE RELATIVELY MORE EXPENSIVE THAN THEIR 'MADE IN THE US' ALTERNATIVES.
Thus SINGAPORE GOODS & SERVICES WILL BE LESS COMPETITIVELY PRICED, meaning LESS will be DEMANDED leading to an INCREASE IN THE SUPPLY OF SGD (And a DEPRECIATION of the SGD) and a subsequent INCREASE IN THE DEMAND FOR USD. (Causing an APPRECIATION of the USD)

--RELATIVE GROWTH RATE--

If one of SINGAPORE'S REGULAR TRADING PARTNERS' (THE US) EXPERIENCES RELATIVELY LOWER LEVELS OF ECONOMIC GROWTH, then it is likely to LEAD TO A RISE IN DEMAND FOR US IMPORTS (RELATIVE TO ANY INCREASE IN DEMAND FOR SINGAPORE EXPORTS TO THE US)
Hence there would be an overall INCREASE IN SUPPLY OF SGD (And a DEPRECIATION of the SGD) and a subsequent INCREASE IN THE DEMAND FOR THE USD. (Causing an APPRECIATION of the USD),

--INVESTMENT-RELATED--

--OUTWARD FDI & PORTFOLIO INVESTMENT--

If a SINGAPOREAN MNC WISHES TO INVEST IN PRODUCTION FACILITIES IN THE US[FDI], or indeed SINGAPOREANS WISH TO BUY FINANCIAL INVESTMENTS SUCH AS BONDS AND SHARES IN US COMPANIES then they will require USD.
Hence greater levels of FDI and investment in the US, will result in an INCREASE IN THE SUPPLY OF SGD (And a DEPRECIATION of the SGD) and a subsequent INCREASE IN THE DEMAND FOR THE USD. (Causing an APPRECIATION of the USD), and vice versa.

--RELATIVE INTEREST RATES--

BONDS and SAVINGS are one of the MAIN FINANCIAL INSTRUMENTS used by investors to GAIN A RETURN ON THEIR MONEY
Therefore IF SAVING AND BONDS IN THE US YIELD A GREATER REWARD IN TERMS OF INTEREST EARNED RELATIVE TO SINGAPORE, then there will likely be an INCREASE IN THE SUPPLY OF SGD (And a DEPRECIATION of the SGD) and a subsequent INCREASE IN THE DEMAND FOR USD causing an APPRECIATION of the USD), and vice versa.

--OTHER FACTORS--

--LEVEL OF OUTWARD REMITTANCES--

TRANSFERS refer to PAYMENTS FROM ONE COUNTRY, THAT DO NOT RECEIVE A GOOD OR SERVICE IN RETURN.
In most cases, these come in the form of REMITTANCES which are EARNINGS SENT BY FOREIGN WORKERS TO FAMILY MEMBERS BACK IN THEIR HOME COUNTRIES.
If REMITTANCES FROM SINGAPORE TO THE US INCREASED then there would be an INCREASE IN THE SUPPLY OF SGD (And a DEPRECIATION of the SGD) as would the DEMAND FOR USD (Leading to an APPRECIATION of the USD).

--SPECULATION (DEPRECIATION)--

TO DEPRECIATE, THEY WILL SEEK TO SELL SGD NOW, in the hope of BUYING IT LATER AFTER ITS VALUE DECREASES, thereby MAKING A PROFIT. However, as they SELL the currency THE SUPPLY OF SGD INCREASES causing it to DEPRECIATE; there is, therefore, a self-fulfilling prophecy at work.

--CENTRAL BANK INTERVENTION--

EVERY CENTRAL BANK HOLDS IT OWN DOMESTIC CURRENCY RESERVES that they sometimes buy or sell in order to INFLUENCE THE VALUE OF THE CURRENCY.
IF THE CENTRAL BANK WISHES TO DECREASE THE DEMAND FOR ITS CURRENCY, IT WILL SELL SOME OF ITS OWN CURRENCY IN EXCHANGE FOR SOME FOREX
In doing so THE SUPPLY OF SGD INCREASES causing it to DEPRECIATE.

--FACTORS AFFECTING DEMAND & SUPPLY--

--RELATIVE INFLATION RATES--

As mentioned above, IF THE INFLATION RATE IN SINGAPORE IS LOWER THAN THE INFLATION RATE IN THE US, it would imply that SUBSTITUTABLE GOODS & SERVICES 'MADE IN SINGAPORE', ARE RELATIVELY CHEAPER THAN THEIR 'MADE IN THE US' ALTERNATIVES.
Thus SINGAPORE GOODS & SERVICES WILL BE MORE COMPETITIVELY PRICED, meaning MORE will be DEMANDED leading to an INCREASE IN THE DEMAND FOR SGD (And an APPRECIATION of the SGD) AT THE SAME TIME, Singaporeans will wish to buy less 'Made in the US' hence there will also be a FALL IN THE SUPPLY OF SGD.

--RELATIVE INTEREST RATES--

As mentioned above, BONDS and SAVINGS are one of the MAIN FINANCIAL INSTRUMENTS used by investors to GAIN A RETURN ON THEIR MONEY
Therefore IF SAVING AND BONDS IN SINGAPORE YIELD A GREATER REWARD IN TERMS OF INTEREST EARNED RELATIVE TO THE US, then there will likely be an INCREASE IN DEMAND FOR SGD (And an APPRECIATION of the SGD) AT THE SAME TIME, Singaporeans will wish to invest less in the US, hence there will also be a FALL IN THE SUPPLY OF SGD.

--CONSEQUENCES OF CHANGES--

--COST PUSH INFLATION--

--DEPRECIATION--

A DEPRECIATION, causes IMPORTS to become MORE EXPENSIVE.
IF DOMESTIC PRODUCERS ARE HEAVILY DEPENDENT ON IMPORTED FOPs, their COSTS OF PRODUCTION will INCREASE.
This will CREATE COST-PUSH INFLATION and SHIFT THE SRAS LEFTWARDS.
The MORE INELASTIC the demand for the imported input (such as the demand for oil), the GREATER is the COST-PUH INFLATION

--APPRECIATION--

AN APPRECIATION will cause IMPORTS to become CHEAPER.
As such DOMESTIC PRODUCERS which use IMPORTED FOPs, will see their COSTS OF PRODUCTION DECREASE.
This will REDUCE INFLATIONARY PRESSURE and SHIFT THE SRAS RIGHTWARDS.

--DEMAND PULL INFLATION--

--DEPRECIATION--

A DEPRECIATION makes EXPORTS CHEAPER and IMPORTS MORE EXPENSIVE.
Therefore there is an INCREASE in THE NUMBER of EXPORTS and a DECREASE in THE NUMBER OF IMPORTS, thus INCREASING NET EXPORTS 'NX' (X−M)
This in turn INCREASES AD, causing a RIGHTWARD SHIFT of the aggregate demand curve.
If the economy is AT FULL EMPLOYMENT, this will likely LEAD TO DEMAND-PULL INFLATION.

--APPRECIATION--

An APPRECIATION makes EXPORTS MORE EXPENSIVE and IMPORTS CHEAPER.
Therefore there is a DECREASE in THE NUMBER of EXPORTS and an INCREASE in THE NUMBER OF IMPORTS, thus DECREASING NET EXPORTS 'NX' (X−M).
This in turn DECREASES AD, causing a LEFTWARD SHIFT of the aggregate demand curve.
This will LEAD TO DOWNWARD PRESSURE ON PRICES and REDUCED INFLATION.

--BALANCE OF PAYMENTS--

--DEPRECIATION--

A DEPRECIATION causes the PRICE of IMPORTED GOODS to become more EXPENSIVE and EXPORTS to become CHEAPER, hence the TRADE BALANCE is LIKELY to IMPROVE.

--APPRECIATION--

AN APPRECIATION causes the PRICE of IMPORTED GOODS to become CHEAPER and EXPORTS to become MORE EXPENSIVE, hence the TRADE BALANCE is LIKELY to WORSEN.

--LIVING STANDARDS--

--DEPRECIATION--

A DEPRECIATION causes the PRICE of IMPORTED GOODS to become more EXPENSIVE and if this leads to COST-PUSH INFLATION, the COST OF LIVING will RISE, and REAL INCOMES will FALL.

--APPRECIATION--

AN APPRECIATION causes the PRICE of IMPORTED GOODS to become CHEAPER and if this leads to DOWNWARD PRESSURE ON PRICES, the COST OF LIVING will FALL, and REAL INCOMES will RISE.

--FOREIGN DEBT--

--DEPRECIATION--

A DEPRECIATION causes the VALUE OF FOREIGN DEBT to RISE as the country now needs to EXCHANGE MORE OF ITS CURRENCY for the same level of foreign debt.

--APPRECIATION--

AN APPRECIATION causes the VALUE OF FOREIGN DEBT to FALL as the country now needs to EXCHANGE LESS OF ITS CURRENCY for the same level of foreign debt.

--ECONOMIC GROWTH--

--DEPRECIATION--

A DEPRECIATION means that EXPORTS are CHEAPER, while IMPORTS become MORE EXPENSIVE, so NET EXPORTS INCREASE leading to an INCREASE in AD and REAL GDP.
As EXPORTS INCREASE, EXPORT-ORIENTATED FIRMS will INVEST in MORE INFRASTRUCTURE and CAPITAL GOODS => POTENTIAL OUTPUT LEVELS INCREASING => LRAS INCREASES => INCREASES IN LRAS and REAL GDP.
HOWEVER if the IMPORTS are ESSENTIAL and the country is UNABLE TO FIND ALTERNATIVE SOURCES, this can LEAD TO COST-PUSH INFLATION => DECREASE IN SRAS and REAL GDP.

--APPRECIATION--

An APPRECIATION means that EXPORTS are MORE EXPENSIVE, while IMPORTS become CHEAPER, so NET EXPORTS DECREASE leading to a DECREASE in AD and REAL GDP.
However, if the IMPORTS are ESSENTIAL and major inputs, this can LEAD TO A FALL IN THE COSTS OF PRODUCTION => INCREASE IN SRAS and REAL GDP.
If this allows a country to import ESSENTIAL CAPITAL GOODS CHEAPLY, then this may FACILITATE GROWTH and INCREASES IN PRODUCTIVITY leading to INCREASES IN LRAS and REAL GDP.

--UNEMPLOYMENT--

--DEPRECIATION--

A DEPRECIATION leads to GREATER NET EXPORTS and as AD INCREASES CYCLICAL UNEMPLOYMENT FALLS (If in RECESSION), in addition, there is MORE EMPLOYMENT IN THE EXPORT INDUSTRY.
Moreover, the export-orientated sector will invest in MORE INFRASTRUCTURE & CAPITAL GOODS => POTENTIAL OUTPUT LEVELS INCREASING => LRAS IN CREASES =. INCREASES IN REAL GDP=> MORE EMPLOYMENT => LOWER NRU.
HOWEVER If the DEPRECIATION leads to COST-PUSH INFLATION, UNEMPLOYMENT RISES.

--APPRECIATION--

An APPRECIATION leads to LOWER NET EXPORTS and as AD DECREASES CYCLICAL UNEMPLOYMENT RISES, in addition, there is LESS EMPLOYMENT IN THE EXPORT INDUSTRY.
Moreover, the export-orientated sector will HAVE LESS TO INVEST in MORE INFRASTRUCTURE & CAPITAL GOODS => POTENTIAL OUTPUT LEVELS DECREASING => LRAS DECREASES =. DECREASES IN REAL GDP=> LESS EMPLOYMENT => HIGHER NRU.
However, If this allows a country to import ESSENTIAL CAPITAL GOODS CHEAPLY, then this may FACILITATE GROWTH and INCREASES IN PRODUCTIVITY leading to INCREASES IN LRAS and REAL GDP and subsequently HIGHER EMPLOYMENT.

--FIXED-RATE SYSTEM--

--DEFINITION--

In a FIXED exchange rate system, EXCHANGE RATES are FIXED BY THE CENTRAL BANK OF EACH COUNTRY, and are NOT PERMITTED TO CHANGE in response to changes in currency supply and demand.
MAINTAINING THE FIXED RATE REQUIRES CONSTANT INTERVENTION BY THE CENTRAL BANK or government of each country.
When the RATE IS FIXED HIGHER it is called a 'REVALUATION', and when the RATE IS FIXED LOWER it is called a 'DEVALUATION'

--MAINTAINANCE--

--UPWARD PRESSURE--

--SELL SGD & BUY FOREX--

If there is an INCREASE IN THE DEMAND FOR SGD it puts UPWARD PRESSURE on the fixed-rate, therefore IN ORDER TO COUNTER THIS the CENTRAL BANK will intervene and SELL ITS SGD RESERVES and BUY FOREX in exchange, this means the SUPPLY OF SGD on the foreign-exchange market will RISE, eliminating the upward pressure.

--TASK--

SKETCH THE DIAGRAM THAT GOES WITH THIS EXPLANATION

--RWE--

China-sets-out-policies-stem-fast-yuan-appreciation

--TASK--

SKETCH THE DIAGRAM THAT GOES WITH THIS EXPLANATION

--RWE--

China-sets-out-policies-stem-fast-yuan-appreciation

--DOWNWARD PRESSURE--

--SELL FOREX & BUY SGD TO RAISE SGD DEMAND--

If there is an INCREASE IN THE SUPPLY OF SGD it puts DOWNWARD PRESSURE on the fixed-rate, therefore in order to counter this the central bank will intervene and BUY THE EXCESS SGD by SELLING ITS FOREX RESERVES in exchange*, this means the DEMAND FOR SGD in the foreign exchange market will RISE, eliminating the downward pressure.
*A country only has a limited amount of FOREX, therefore they will not be able to counter downward pressure indefinitely, in this way, and will need to find other ways to increase demand for their currency.

--TASK--

SKETCH THE DIAGRAM THAT GOES WITH THIS EXPLANATION

--RAISE INTEREST RATES TO RAISE SGD DEMAND--

If there is an INCREASE IN THE SUPPLY OF SGD it puts DOWNWARD PRESSURE on the fixed-rate, therefore in order to counter this the CENTRAL BANK will intervene and RAISE INTEREST RATES, this means the DEMAND FOR SGD in the foreign exchange market will RISE, as investors will be ATTRACTED BY THESE HIGHER RATES, thus eliminating the downward pressure.
Higher-interest-rates-will-not-save-the-pound-nor-will-a-weaker-currency-prop-up-the-uk-stock-market?
Pound-plummet-underlines-schoolboy-error-by-kwasi-kwarteng

--TASK--

SKETCH THE DIAGRAM THAT GOES WITH THIS EXPLANATION

--BORROW FOREX & BUY SGD TO RAISE SGD DEMAND--

If there is an INCREASE IN THE SUPPLY OF SGD it puts DOWNWARD PRESSURE ON THE FIXED RATE, therefore IN ORDER TO COUNTER THIS the government can BORROW FOREX and then SELL IT IN EXCHANGE FOR SGD, thus INCREASING THE DEMAND FOR SGD and eliminating the downward pressure.

--LIMIT IMPORTS TO REDUCE SUPPLY OF SGD--

If there is an INCREASE IN THE SUPPLY OF SGD TO BUY IMPORTS which puts DOWNWARD PRESSURE on the fixed rate, the GOVERNMENT CAN USE POLICIES TO REDUCE REDUCE SPENDING ON IMPORTS?

1) CONTRACTIONARY POLICY (BOTH FISCAL & MONETARY) LOWERS AD and INCOMES, which REDUCES THE DEMAND FOR IMPORTS, and REDUCES the SUPPLY OF SGD, however, these policies may conflict with other economic objectives such as low unemployment and economic growth.

2) TRADE PROTECTIONIST POLICIES such as TARIFFS etc.., MAKE IMPORTS MORE EXPENSIVE which REDUCES THE DEMAND FOR IMPORTS and hence REDUCE THE SUPPLY OF SGD, however, this can have an adverse impact on relationships with trading partners who may retaliate.

--EXCHANGE CONTROLS TO REDUCE SUPPLY OF SGD--

If there is an increase in the supply of SGD it puts DOWNWARD PRESSURE on the fixed-rate, therefore in order to counter this the government can IMPOSE A MAXIMUM LIMIT ON THE AMOUNT OF FOREX THAT CAN BE BOUGHT, thus controlling the supply of SGD.
TAIWAN FLOATS FX CONTROLS

--REAL-WORLD EXAMPLE: BLACK WEDNESDAY 92'--

--REAL-WORLD EXAMPLE: ASIAN FINANCIAL CRISIS 97'--

--REAL-WORLD EXAMPLE: GBP FALLING--

https://www.bbc.com/news/business-49179234

--MANAGED-RATE SYSTEM--

--DEFINITION--

In a MANAGED-RATE SYSTEM exchange rates are for the most part free to float to their market levels (i.e. their equilibrium levels) OVER LONG PERIODS OF TIME; however, CENTRAL BANKS PERIODICALLY INTERVENE to STABILISE them in the SHORT-TERM and allow time for markets to adjust.

--RATIONALE--

The objective of central bank intervention is to PREVENT LARGE AND ABRUPT FLUCTUATIONS IN EXCHANGE RATES which disrupt the orderly flow of international trade and CREATE UNCERTAINTIES that UNDERMINE INVESTMENT and ECONOMIC ACTIVITY.

--PEGGED RATE SYSTEM--

--DEFINITION--

A PEGGED CURRENCY is allowed TO FLUCTUATE WITHIN A NARROW RANGE ABOVE and BELOW the TARGET EXCHANGE RATE.
E.G https://www.scmp.com/yp/discover/advice/article/3093224/what-hong-kong-us-dollar-peg-and-how-does-it-workpegge\
pegged currency is allowed to fluctuate only within a narrow range above and below a target exchange rate relative to the dollar or the euro, so that if the actual exchange rate hits the upper or lower limit of the range, the central bank intervenes to keep it within the limits. This implies that when the USD depreciates (appreciates) against a currency then it must also be true that the pegged currency also depreciates (appreciates).
E.G If 1USD = 2GBP and IUSD = 5SGD and the

--EXAMPLE--

IMAGINE THAT SINGAPORE'S BIGGEST TRADING PARTNER WAS THE UK
AS SUCH IT HAS PEGGED ITS EXCHANGE. RATE @ 1 GBP : 6 SGD
AT THE SAME TIME 1 GBP : 2 HKD MEANING THAT 1 HKD : 3 SGD
IF THE GBP DEPRECIATES AGAINST THE HKD TO 1 GBP : 1 HKD, THEN. IN A FREE-FLOATING SYSTEM 1 GBP : 3 SGD.
AS SUCH IN ORDER TO MAINTAIN THE 1 GBP : 6 SGD PEG THE SGD MUST ALSO DEPRECIATE AGAINST THE HKD TO 1 HKD : 6 SGD

OVERVALUED

An OVERVALUED currency is one that has a value that is SET TOO HIGH RELATIVE TO ITS FREE MARKET VALUE, hence there exists DOWNWARD PRESSURE.

UNDERVALUED

An UNDERVALUED currency is one whose value is SET TOO LOW RELATIVE TO ITS FREE MARKET VALUE; hence there exists UPWARD PRESSURE.

--CONSEQUENCES--

OVERVALUED

IMPORTS CHEAPER:

(+) IMPORTS OF CAPITAL GOODS, RAW-MATERIALS and other INPUTS for use in manufacturing industries help to SPEED UP INDUSTRIALISATION in developing countries.
(-) GREATER COMPETITION for domestic producers from cheaper imports => UNEMPLOYMENT.

EXPORTS MORE EXPENSIVE:

(-) Makes domestic EXPORTS UNCOMPETITIVE, leading to UNEMPLOYMENT in exporting industry.

UNDERVALUED

IMPORTS MORE EXPENSIVE:

(-) IMPORTS OF CAPITAL GOODS, RAW-MATERIALS, and other INPUTS can lead to COST-PUSH INFLATION.
(+) LESS COMPETITION for domestic producers from cheaper imports.

EXPORTS LESS EXPENSIVE:

(+) MAKES DOMESTIC EXPORTS competitive, leading to EMPLOYMENT in exporting industry as it expands *
* Some developing countries have used undervaluation as a method to expand their export industries, expand their economies and therefore also increase their employment levels. Achieving these objectives by means of an undervalued currency is considered to involve the creation of an unfair competitive advantage. Currency undervaluation is therefore considered to be a kind of ‘cheating’. In the context of a managed float, undervalued currencies are sometimes referred to as a ‘DIRTY FLOAT’. Correction of the undervalued currency would involve revaluation or appreciation of the currency.

--FIXED vs FLOATING--

--PAST PAPER TIPS: WHAT IS LIKELY TO BE TESTED--

WHAT IS LIKELY TO BE TESTED:

X-RATE DIAGRAM SHOWING ONE SHIFT IN EITHER THE DEMAND OR SUPPLY OF A CURRENCY
AD/AS DIAGRAM SHOWING HOW X-RATE CHANGE IMPACTS COMPONENT OF AD or AS
IMPACT OF AN APPRECIATING CURRENCY ON ECONOMIC PERFORMANCE (EMPLOYMENT, GROWTH, PRICE STABILITY...)
IMPACT OF A DEPRECIATING CURRENCY ON ECONOMIC PERFORMANCE (EMPLOYMENT, GROWTH, PRICE STABILITY...)
PROS & CONS OF FIXED vs FLOATING
PROS & CONS OF OVER/UNDER VALUED CURRENCIES

--CALCULATIONS--

--THE VALUE OF A CURRENCY IN TERMS OF ANOTHER--

Q. 1 CAD = 0.99 USD, what is the value of 1 USD in terms of CAD?

I USD = 1/0.99 = 1.01 CAD

Q. 1 INR = 1..84 YEN, what is the value of 1 YEN in terms of INR?

I YEN = 1/1.84 = 0.54 INR

Q. 1 GBP = 1.62 CAD, what is the value of 1 CAD in terms of GBR?

I CAD = 1/1.62 = 0.62 GBP

--INTERPRETING EXCHANGE RATE DATA--

--HAS THE USD APPRECIATED or DEPRECIATED?--

Ask yourself: Has the USD become MORE or LESS EXPENSIVE in terms of the SGD? Do you give up MORE or LESS SGD to purchase a single USD?

--PERCENTAGE CHANGES IN CURRENCY VALUES--

--WORK OUT APPRECIATION as a %, using DATA--

The SGD has APPRECIATED AGAINST THE USD, between January and December, but by how much as a %?
In other words how much more USD must be exchanged for an SGD?

We can see that the price of an SGD (in terms of USD) increased (Appreciated) from 1.22 to 1.69 USD, which is a % increase of (1.69-1.22)/1.22 = +38.52%

--WORK OUT DEPRECIATION as a %, using DATA--

The USD has DEPRECIATED AGAINST THE SGD, between January and December, but by how much as a %?
In other words how much more SGD must be exchanged for a USD?

- In order to work this out we need to convert the exchange rates into SGD per USD values, so:
  - - in JAN 1/1.22 I USD = 0.81 SGD
    - in Dec 1/1.69 1 USD = 0.59 SGD
We can see that the price of a USD (in terms of SGD) decreased (Depreciated) from 0.81 to 0.59 SGD, which is a % decrease of (0.81-0.59)/0.81 = -27.1%

--DEMAND FOR SGD CREATES A SUPPLY OF USD--

WHEN USD HOLDERS WISH TO PURCHASE SOMETHING PRICED IN SGD, they will need to exchange it in the foreign exchange market.
In doing so they simultaneously INCREASE IN THE SUPPLY OF USD (Causing a RIGHTWARD SHIFT in the USD SUPPLY CURVE curve, resulting in a DEPRECIATION OF THE USD),...
...and an INCREASE IN THE DEMAND FOR SGD, (Causing a RIGHTWARD SHIFT in the SGD demand curve resulting in an APPRECIATION OF THE SGD)

--PRINT UNIT MCQ--

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