Explain two factors which influence the value of a currency in a floating exchange rate system.

Using real-world examples, discuss the consequences of a fall in a country’s exchange rate.

Answers may include:

• Definition: floating exchange system.
• Explanation: an explanation of how the value of a floating exchange rate is determined, including demand for exports and imports, speculation, relative interest rates, remittances, portfolio flows, relative inflation rates, foreign direct investment.
• Diagram: demand and supply diagram to show determination of an exchange rate.

Answers may include:

• Definition: exchange rate.
• Explanation: of consequences such as changes in the price level, economic growth, employment, quantities of imports and exports depending on elasticities, effects on competitiveness and changes in government policy.
• Diagram: supply and demand diagram to show reduced demand or increased supply of a currency.
• Synthesis (discuss): the magnitude of the reduction in the exchange rate, whether the economy is impacted positively or negatively in terms of growth, unemployment and inflation, effects on different sectors such as tourism and agriculture.
• Examples: real-world examples of countries which have experienced the consequences of a reduced exchange rate.

N.B. It should be noted that definitions, theory and examples that have already been given in part (a), and then referred to in part (b), should be rewarded.