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You are expected to explain/analyze (AO2) managed exchange rates and undervalued/overvalued currencies (SL+HL), and draw (AO4) diagrams showing exchange rate determination in a managed exchange rate system (SL+HL)
A managed exchange rate is one where the central bank periodically intervenes to influence its currency's exchange rate. The central bank might have a target range they want the equilibrium price to be within.
It is therefore similar to fixed rates, but does not have a specific rate. Rather, it has a range:
Overvalued Currencies (AO2)
Overvalued Currencies (AO2)
A currency is overvalued when its value is above its equilibrium value in the long run.
This occurs when the central bank consistently intervenes to keep the value above. In a floating exchange rate market, equilibrium would be corrected.
This means imported goods are cheaper than what they should be, while exports become more expensive. This reduces inflationary pressures, but will reduce domestic firm revenue.
This means overvaluing your currency could be used to reduce inflation, but comes at the cost of hampering your industry.
Undervalued Currencies (AO2)
Undervalued Currencies (AO2)
A currency is undervalued when its value is below its equilibrium value in the long run.
This occurs when the central bank consistently intervenes to keep the value below. In a floating exchange rate market, equilibrium would be corrected.
This means imported goods are more expensive than what they should be, while exports become cheaper. This will improve domestic producer revenue, but may cause inflation due to all the excess demand.
This means undervaluing your currency could be used to increase GDP, but comes at the cost of inflation.
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