D a s a 0 quantity of a price of a e equilibrium

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D $A S $A 0 Quantity of $A Price of $A (e) Equilibrium exchange rate(e) Fixed ‘e’ Fixed ‘e’ Overvalued Undervalued
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45 Speculative attacks on the currency D $A S $A 0 Quantity of $A Price of $A (e) Equilibrium exchange rate (e) Fixed exchange rate Central Bank RBA is required to buy $A to maintain the fixed exchange rate
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46 The (Fixed) Exchange R ate and Monetary P olicy Expansionary Monetary Policy Lower real interest rate Capital outflow: to maintain value of exchange rate central bank buys $A Monetary policy ineffective Contractionary Monetary Policy Higher real interest rate Capital inflow: to maintain value of exchange rate central bank sells $ Monetary policy is ineffective
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Potential Conflict for Policymakers Stabilize the currency, verses Stabilise the domestic economy While higher real interest rates might stabilize the economy and stop a speculative attack, they can have a contractionary effect on the domestic economy. By adopting a fixed exchange rate, a country effectively gives-up the use of monetary policy for domestic stabilization.
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48 4. Fixed or Flexible exchange rates Flexible exchange rates Allows an independent monetary policy Insulates economy against shocks Fixed exchange rates Reduce uncertainty However Cannot operate an independent monetary policy Speculative attacks
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49 What is important in this topic? Defining exchange rates the difference between nominal and real exchange rates Exchange rate theories PPP: purchasing power parity Demand and Supply of $A Exchange rate regimes Fixed Flexible Applications
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