How does a floating exchange rate provide an automatic adjustment mechanism for balance of payments imbalances?

A deficit causes the currency to depreciate, making exports cheaper and imports dearer, which helps correct the imbalance; a surplus causes appreciation with the opposite effect.

Why does a floating exchange rate allow monetary policy independence?

Interest rates can be set for domestic economic objectives such as controlling inflation or stimulating growth, rather than being used to defend a fixed exchange rate.

Why is there no need to hold large foreign currency reserves under a floating exchange rate system?

The government does not need to intervene in the foreign exchange market to maintain a specific rate, so reserves are not required for this purpose.

What is a key disadvantage of exchange rate volatility under a floating system?

It creates uncertainty for international trade and investment, as businesses cannot predict future exchange rates when planning transactions.

How might a floating exchange rate lead to destabilising speculation?

Speculators may amplify currency movements by buying rising currencies and selling falling ones, causing excessive volatility beyond what fundamentals justify.

AQA A-Level Economics 7136

Economic Methodology and the Economic Problem

Topic overview Economics as a social science, and positive and normative statements The economic problem, factors of production and opportunity cost Production possibility diagrams

Individual Economic Decision Making

Topic overview Consumer behaviour and utility Imperfect information Aspects of behavioural economic theory Behavioural economics and economic policy

Price Determination in a Competitive Market

Topic overview Demand, the demand curve, income and wealth Substitutes, complements and consumer preferences Price elasticity of demand and total revenue The determinants of price elasticity of demand Income and cross elasticity of demand The determinants of supply Price elasticity of supply Equilibrium, disequilibrium and how a market clears Shifts in demand and supply, and the price mechanism The interrelationship between markets

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Perfect Competition, Imperfectly Competitive Markets and Monopoly

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The Labour Market

Topic overview The demand for labour and marginal productivity theory The supply of labour Wage determination in competitive labour markets Wage determination in imperfectly competitive labour markets Trade unions and wage determination The National Minimum Wage Discrimination in the labour market

The Distribution of Income and Wealth: Poverty and Inequality

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The Market Mechanism, Market Failure and Government Intervention

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The Measurement of Macroeconomic Performance

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How the Macroeconomy Works

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Economic Performance

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Financial Markets and Monetary Policy

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Fiscal Policy and Supply-Side Policies

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The International Economy

Topic overview The causes and characteristics of globalisation The impact of globalisation on developed and developing economies Multinational corporations Comparative and absolute advantage The effects of trade and changing trade patterns Tariffs, quotas and the tariff diagram Arguments for and against protectionism Trading blocs and the World Trade Organisation The components of the balance of payments Causes of current account imbalances and investment flows Correcting imbalances and their consequences How exchange rates are determined in a floating system Government intervention and fixed exchange rates Floating rates and currency unions Growth, development and less-developed economies Measuring development: the HDI and other indicators Investment and education as drivers of development Corruption, governance and institutional barriers Infrastructure, human capital and property rights Market-based and interventionist development strategies Aid and trade as development strategies Growth, globalisation and inequality

The International Economy

Floating rates and currency unions

3 things to know
Papers 2 and 3

Overview

The advantages and drawbacks of floating, and what a country gains and gives up by joining a currency union.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Evaluation

Explain how currency depreciation under a floating system can cause imported inflation.

Key term

Give an example of a currency union.

Evaluation

Why might a single interest rate be problematic for currency union members?

Questions from this subtopic

Each one with the model answer underneath.

1
How does a floating exchange rate provide an automatic adjustment mechanism for balance of payments imbalances?
Model answer
A deficit causes the currency to depreciate, making exports cheaper and imports dearer, which helps correct the imbalance; a surplus causes appreciation with the opposite effect.
2
Why does a floating exchange rate allow monetary policy independence?
Model answer
Interest rates can be set for domestic economic objectives such as controlling inflation or stimulating growth, rather than being used to defend a fixed exchange rate.
3
Why is there no need to hold large foreign currency reserves under a floating exchange rate system?
Model answer
The government does not need to intervene in the foreign exchange market to maintain a specific rate, so reserves are not required for this purpose.
4
What is a key disadvantage of exchange rate volatility under a floating system?
Model answer
It creates uncertainty for international trade and investment, as businesses cannot predict future exchange rates when planning transactions.
5
How might a floating exchange rate lead to destabilising speculation?
Model answer
Speculators may amplify currency movements by buying rising currencies and selling falling ones, causing excessive volatility beyond what fundamentals justify.
6
Explain how currency depreciation under a floating system can cause imported inflation.
Model answer
A weaker currency makes imports more expensive, raising the cost of imported goods and raw materials, which feeds through into higher domestic prices.

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Production, Costs and Revenue

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AA higher bank rate increases borrowing costs.

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Monopsony means a market dominated by one buyer.

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