MYTUTOR SUBJECT ANSWERS

1136 views

Explain what is meant by a semi-fixed exchange rate? With reference to the BBC news story in the link below, explain why the Nigerian central bank increased interest rates and devalued their currency (the naira)?

http://www.bbc.co.uk/news/business-30196496

 

An exchange rate is the price of one currency in terms of another. When this rate is semi-fixed the exchange rate is allowed to fluctuate between a specified range before an institution, usually a central bank, will intervene.

Should the exchange rate deviate from this institution has two main mechanisms at their disposable: Interest rates and foreign currency reserves.

The Nigerian central bank operates the naira on a semi-fixed exchange rate system with the target band of the naira being 160-176 NGN to the dollar.

Falling oil prices are likely to apply downward pressure on the naira as this currency is used to pay for the oil Nigeria exports. As such, when the price of oil goes down less naira is required to purchase the oil which means that the demand for the currency will fall in the short term. The extent to which the demand falls depends on how large a proportion of total export value oil is. The larger it is the greater this fall in demand will be. Falling currency demand, just like for other markets, leads to a fall in the price/value of the Naira.

From the news story we read that this led to the central bank increasing interest rates and intervening in the forex markets with reserves. It increased interest rates as this could offset the depreciation occurring due to the falling oil prices. Higher interest rates increase hot money flows (the flow of money into a county due to the better return on savings or investments) which drive up demand for the currency. The extent to which this appreciates the currency depends on the size of the increase in interest rates and the magnitude of interest rates relative to other nations. This was used in addition to the foreign currency that is held by the central bank. Foreign currency can be used to purchase Naira therefore boosting demand, just like higher interest rates.

Secondly, we can determine that both higher interest rates and the use of foreign currency reserves was not offsetting the fall in value the Naira was experiencing. The central bank reduced the semi-fixed range to 150-160. This range is likely closer to the market equilibrium as there is less downside pressure on the currency. Less pressure means that the higher interest rates in tandem with some intervention in the forex market will now be able to restore stability to the Nigerian Naira.

 

Owen C. A Level Economics tutor, GCSE Maths tutor, GCSE Economics tutor

2 years ago

Answered by Owen, an A Level Economics tutor with MyTutor

Still stuck? Get one-to-one help from a personally interviewed subject specialist

49 SUBJECT SPECIALISTS

£24 /hr

Jon S.

Degree: Economics & Bioscience (Bachelors) - Exeter University

Subjects offered: Economics, Maths+ 1 more

Economics
Maths
Biology

“I'm a first year student at Exeter University studying  Bioscience & Economics. I've enjoyed teaching for over a year now and I'm hoping my tutorials engage you with your subject, or at the very least help you get the grade you are lo...”

£20 /hr

Anahita G.

Degree: Maths and Economics (Bachelors) - York University

Subjects offered: Economics, Science+ 3 more

Economics
Science
Maths
Chemistry
.TSA. Oxford.

“I am a maths and economics student at the University of York. I have always loved logical and analytical subjects, for example Maths and the Sciences. I also particularly enjoy economics as there are countless ways to analyse and conc...”

£24 /hr

Tom H.

Degree: Economics (Bachelors) - Durham University

Subjects offered: Economics, Spanish+ 3 more

Economics
Spanish
Maths
French
Business Studies

“Top tutor from Durham University, ready to help you improve your grades, all the way to A*.”

About the author

Owen C.

Currently unavailable: no new students

Degree: Economics (Bachelors) - Exeter University

Subjects offered: Economics, Maths

Economics
Maths

“An aspiring Economist looking to share his enthusiasm and get tutees the highest grades.”

You may also like...

Other A Level Economics questions

Define the term 'income inequality'

What is meant by an oligopoly being both interdependent and uncertain in their price strategies?

What is the difference between macro and micro economics?

What is fiscal policy?

View A Level Economics tutors

Cookies:

We use cookies to improve our service. By continuing to use this website, we'll assume that you're OK with this. Dismiss

mtw:mercury1:status:ok