3.2 C Effects of high/low exchange rates (and what governments tend to do about them). Chapter 23 Pages 287-289. Learning Objectives. Evaluate the possible economic consequences of a change in the value of a currency, including the effects on a country’s inflation rate, employment ,
[what type of exchange rate “regime” is assumed?]
Trading partners’ currency is more expensive in the FOREX.
Domestic currency is less expensive compared to the trading partners’ currency,
Summary effect when a currency depreciates, on:
3.2 D governments tend to do about them)LO: Compare and contrast a fixed exchange rate system with a floating exchange rate system, with reference to any of four major factors.
Short term volatility: fluctuations are painful for firms due to uncertainty.
Ruins firms if they persist at high levels (and depress growth).
If exchange rates remain too low, inflation may “set in”
Smaller economies are more vulnerable to large flows of investment funds (“hot money”) due to speculation or fearful events.
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.”