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>> Open-Economy Macroeconomics Section 4: Exchange Rates and Macroeconomic Policy chapter 19 A look at the history of British macroeconomic policy over the past 50 years touches on all the themes we’ve covered in our study of macroeconomics so far: British policy mak- ers have wrestled with inflation and unemployment and wondered how to get faster long-run growth. But British macroeconomic history also reveals other concerns— notably, whether to fix the exchange rate of the pound, and if so at what level. As we learned in the opening story, the possibility of future changes in the exchange rate regime looms large even when the exchange rate is floating. And the analysis of monetary poli- cy focuses to a large degree on how it affects the exchange rate and the balance of pay- ments. In other words, the fact that modern economies are open to international trade and capital flows adds a new level of complication to our analysis of macroeconomic pol- icy. Let’s look at three policy issues raised by open-economy macroeconomics.
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2 CHAPTER 19 SECTION 4: EXCHANGE RATES AND MACROECONOMIC POLICY Devaluation and Revaluation of Fixed Exchange Rates Historically, fixed exchange rates haven’t been permanent commitments. Sometimes countries with a fixed exchange rate switch to a floating rate, as Argentina did in 2001. In other cases they retain a fixed rate but change the target exchange rate. Such adjustments in the target were common during the Bretton Woods era. For example, in 1967 Britain changed the exchange rate of the pound against the U.S. dollar from US$2.80 per £1 to US$2.40 per £1. A modern example is China: China maintained a fixed exchange rate against the U.S. dollar from 1994 to 2005 but changed its exchange rate regime in July 2005. A reduction in the value of a currency that is set under a fixed exchange rate regime is called a devaluation. As we’ve already learned, a depreciation is a downward move in a currency. A devaluation is a depreciation that is due to a revision in a fixed exchange rate target. An increase in the value of a currency that is set under a fixed exchange rate regime is called a revaluation. A devaluation, like any depreciation, makes domestic goods cheaper in terms of for-
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This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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