Transcript 3.2 C Effects of exchange rates and evaluating systems N

Chapter 23
Pages 287-292
1.
Evaluate the possible economic consequences of
a change in the value of a currency, including the
effects on a country’s inflation rate, employment,
economic growth and current account balance.
In regard to exports:
 Domestic currency is more expensive compared to
the trading partners’ currency,
 Thus exports are more expensive for them and
thus eXport (receipts)decrease
 This declines export industries
In regard to imports:
 Trading partners’ currency is less expensive in the
FOREX;
 So their imports are less expensive and thus
iMport payments increase
 This also makes domestic producers less
competitive
The good news is:
 imported inputs/raw materials are less expensive
for those industries that depend upon them
 imported consumer goods are less expensive
In regard to imports:
 Trading partners’ currency is more expensive in the
FOREX;
 So their imports are more expensive and thus iMport
payments decreases
 This also makes domestic producers more
competitive
The bad news is:
 imported inputs/raw materials are more expensive
for those industries that depend upon them
 imported consumer goods are more expensive
In regard to Exports:
 Domestic currency is less expensive compared to
the trading partners’ currency,
 Thus exports are less expensive for them and thus
eXport (receipts)increase
 This promotes export industries
 current account balance….
and
thus AD…
 aggregate supply…
 inflation rate…
GDP…
 employment…
and
 current account balance….
and
thus AD…
 aggregate supply…
 inflation rate…
GDP…
 employment…
and
2. Examine the possible consequences of
overvalued and undervalued currencies.
 What is the pressure (price message) in the FOREX to
keep it fixed?
 How might the government continue to apply
monetary policy?
 What is the disadvantage/limitation of this?
 How might the government continue to act in regard
to foreign reserves?
 What is the disadvantage/limitation of this?
 What is the pressure (price message) in the FOREX to
keep it fixed?
 How might the government continue to apply
monetary policy?
 What is the disadvantage/limitation of this?
 How might the government continue to act in regard
to foreign reserves?
 What is the disadvantage/limitation of this?
Put it all together now
Advantages



Disadvantages 


Fixed regime
Ensures no fluctuations so
better for exporters &
importers
Reduces distortions of XrR
caused by speculation
Promotes macroeconomic
stability (e.g. low inflation)
Monetary policy is not
available for Demand Side
operations
Reserves are costly or may be
depleted;
Trading partners may object
to unfair XcR






Floating regime
Free trade is promoted as trade
imbalances are automatically
corrected.
Monetary policy is available
for Demand Side operations
Less reserves are needed (and
used in emergency)
Even short term fluctuations
can harm exporters &
importers
Large flows of investment
funds (“hot money”) distorts a
fair XcR for trade
Greater macro fluctuation
1. Application Task: Student workpoint 23.7
2. Application Task: “You be the journalist”
activity on page 293.
3. Extension Task: Post a “mini
commentary” regarding a news article that
reports a currency problem.
The theory of purchasing-power parity (PPP) says
that, in the long run, exchange rates should move
towards levels that equalise the prices of a basket of
goods and services in different countries—ie, a dollar
should buy the same everywhere.
Therefore, if US$1 = NZ$1.5, then a basket of goods
costing US$240 in USA should cost $NZ360 in New
Zealand.
Consider the most recent Economist Bigmac index, and
an interesting article on the Starbucks index.
Read the start of a discussion at the NY Times, and
search that newspaper for more. Here is an excerpt
from the article QE, currencies and creditors that I
have posted on my blog:
“The gut feeling that I have been expressing for a while is
that the currency set-up is unsustainable and QE only
adds to that sentiment. Can the world’s largest
economy and debtor nation follow a consistent policy
of devaluation, and thus penalising its creditors?”
Read the interesting article from the Economist Is there a
better way to organise the world’s currencies?
“American officials blame China’s refusal to allow the yuan to
rise faster. The Chinese retort that the biggest source of
distortion in the global economy is America’s ultra-loose
monetary policy—reinforced by the Federal Reserve’s
decision on November 3rd to restart “quantitative easing”,
or printing money to buy government bonds (see article)…
The underlying truth is that no one is happy with today’s
international monetary system—the set of rules, norms
and institutions that govern the world’s currencies and the
flow of capital across borders.”