Extract 3 Flashcards
Exchange rate systems: Freely floating exchange rate
A system whereby the price of one currency expressed in terms of another is determined by the forces of demand and supply
Advantages of a freely floating exchange rate (4)
- free to use monetary policy as inflationary control
- Monetary policy more effective (see pg 256)
- BoP problems corrected automatically
- Can adjust to external shocks
Disadvantages of freely floating exchange rate (4)
- Gov’ts can prioritise short term growth over stable inflation
- Reliance on exchange rate depreciations to offset domestic inflation likely to be unsustainable in long run
- Does not always improve balance of payments (Marshall-Lerner condition)
- Loss of control over exchange rate
Exchange rate systems: Fixed Exchange Rate
An exchange rate system in which the value of one currency has a fixed value against other currencies. This rate is often set by the government
Advantages of fixed exchange rate (3)
- reduced uncertainty, country may enjoy higher levels of trade/investment
- reduced cost of trade (firms don’t hedge)
- Imposes discipline on domestic firms, need to keep upping their productivity/competitiveness, cannot rely on depreciations in exchange rate
Disadvantages of fixed exchange rate (4)
- Need to maintain high levels of foreign currency reserves (opportunity cost)
- Loss of control over domestic monetary policy
- chance of international retaliation due to undervaluing of currency
- Speculative ‘attacks’ due to over or undervaluation
Protectionism definition
Gov’t actions/polices that restrict/restrain international trade, usually done with intent to protect local businesses/jobs from foreign competition
Case FOR protectionism (6)
- protects domestic employment
- raises extra gov’t revenue through tariffs
- response to ‘dumping’ of imports
- protect infant industries
- overcome BoP disequilibrium
- Strategic reasons (war, human rights violations)
Case AGAINST protectionism (6)
- misallocation of resources
- danger of “trade wars”
- potential corruption
- increased costs of production due to lack of competition (no incentive to reduce costs)
- higher prices for domestic consumers
- increase costs of imported FOPs
Stages of economic integration (5)
- Free Trade Area
- Customs Union
- Single Market
- Economic Union
- Monetary Union
Free trade Area
-members agree to remove tariffs and quotas between them
-keep their own trade policy with other countries
(trade deflection can still happen
Customs Union
- Members agree to remove tariffs and quotas between them and impose a common tariff on other countries.
NTBs still exist between members though
Single Market
Members agree to remove all barriers to trade such as Non-tariff Barriers (NTBs = restrictions on movement of labour/capital)
Economic Union
Same as single market but economic policy making becomes more centralised, particularly a commmon approach towards area of area of personal and business taxation
Monetary Union
Deepest form of integration in which countries share the same currency and have a common monetary policy as a result
Example of FTA
North American Free Trade Area (NAFTA)
Example of Single Market
European Union (EU) although with some countries it is a Monetary Union
Short term impacts of economic integration (2)
- Trade creation
- Trade diversion
Impact of trade creation/diversion depends on (2)
- Relative efficiencies of the members of the Union and the Non Members
- Prices Elasticities of Demand and Supply
Check pg 273 for details)
Longer- term impacts of economic integration (3)
- reduction in monopoly power
- Greater innovation and R and D (due to increased competition)
- Larger market and economies of scale
Costs of economic integration (2)
- Geographical concentration of industry risks core-periphery problem, could result in significant regional/structural unemployment
- Can result in emergence of oligopolies and monopolies, may require agreements on competition policies (due to formation of price-fixing cartels)
External impact of Economic Integration (3)
- Trade diversion represents a loss in income for those countries outside the econ integrated area
- Poorer countries suffer most due to their dependence on agricultural exports
- For developed countries they can move production to within the economically integrated area and take advantage of this
Impact of Monetary Union on domestic country at microeconomic level (4)
- reduced transition costs
- elimination of exchange rate risks
- increased price transparency
Overall should bring lower prices, lower costs of production, encourage investment and increase competition - Costs of changing currency hits smaller firms harder
Impact of Monetary Union at Macroeconomic level (2)
- Increase in AD through increased trade, investment and competitiveness
- AS should also increase due to lower production costs, greater factor mobility
