27 The Open Economy, Part 3 - 1 27-1 Exchange Rates,...

Info iconThis preview shows pages 1–5. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 1 27-1 Exchange Rates, Business Cycles, and Macroeconomic Policy in the Open Economy, Part 3 27-2 Agenda Fixed Exchange Rates Macroeconomic Policy in an Open Economy with Fixed Exchange Rates Fixed versus Flexible Exchange Rates 27-3 Fixed Exchange Rates Fixed-exchange-rate systems are historically important. The U.S. was on a fixed exchange rate system before the early 1970s. Fixed exchange rates are still used by many countries. 27-4 Fixed Exchange Rates Two key questions: How does the use of a fixed-exchange-rate system affect an economy and macroeconomic policy? Which is the better system, flexible or fixed exchange rates? 2 27-5 Fixed Exchange Rates Fixing the exchange rate: The government sets the exchange rate. Either unilaterally or in agreement with other countries. The official rate is the rate set by the government. What happens if the official rate differs from the fundamental rate determined by the supply and demand of the currency? 27-6 Fixing the exchange rate An overvalued currency: When the official rate is above its fundamental value, the currency is said to be overvalued . 27-7 An overvalued exchange rate Q $ P $ or e nom S $ D $ P $ 27-8 Fixing the exchange rate An overvalued currency: The government has three choices for dealing with an overvalued currency . First , the government could devalue the currency, reducing the official rate to the fundamental value. 3 27-9 Devaluing the currency Q $ P $ or e nom S $ D $ P $ 27-10 Fixing the exchange rate An overvalued currency: The government has three choices for dealing with an overvalued currency . Second , the country could restrict international transactions. This would reduce the supply of its currency to the foreign exchange market and raise the fundamental value of the currency. If a country prohibits people from trading the currency at all, the currency is said to be inconvertible . 27-11 Restricting international transactions Q $ P $ or e nom S $ D $ P $ 27-12 Fixing the exchange rate An overvalued currency: The government has three choices for dealing with an overvalued currency . Third, the central bank can buy (or demand) its own currency to make the fundamental value equal to the official rate. The central bank buys the domestic currency in the foreign exchange market using its official reserve assets . The decline in official reserve assets equals the countrys balance of payments deficit . 4 27-13 Foreign exchange market intervention Q $ P $ or e nom S $ D $ P $ 27-14 Fixing the exchange rate An overvalued currency: An overvalued currency cannot be maintained forever....
View Full Document

This note was uploaded on 07/29/2010 for the course UGBA 100b taught by Professor Wood during the Summer '10 term at University of California, Berkeley.

Page1 / 12

27 The Open Economy, Part 3 - 1 27-1 Exchange Rates,...

This preview shows document pages 1 - 5. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online