Macroeconomics - ER regimes Flashcards
what is official ER
the monetary authority has full control in determining the ER - a pure policy variable
- the country can choose its nominal ER = can easily make conditionality changed requested by IMF
What is a hard peg
- adopts a foreign currency
- no independent currency
- no ER policy = not in control of monetary authorities
what are the 2 types of soft peg
- conventional
- adjusting
what is conventional soft peg
- countries peg their currency to a major currency
- no ER policy - restricts MP
- during crisis can abandon the peg
what is the adjusting soft peg
- ER is pegged to a target band rate for a single currency
- ER can move within a range
- limited policy options
what are the 2 types of floating regimes
- freely floating
- managed float
what is freely floating ER
- ER is market determined
- ER is not a policy variable
- can use IRs to set the rate
what is managed float ER
- monetary authorities intervene if the rate goes outside some target range
- CB manages movement of ER
- ER is an instrument for macroeconomic management
- used to reach inflation target
what happened to official ER why did they change to fixed or flexible
- prior to 1990s - most DCs had official ERs = could change the rate whenever they wanted
- there would be multiple different ERs for exports, imports, tourists = generate a large black market premium
- typically Official ERs would be overvalued
- from 1980s IMF promoted liberalisation to fixed or flexible ER
what is the balance of payments
capital account + current account
on the current account (trade) side what is supply and demand
imports = demand for forex $
exports = demand for LCU + supply of forex
under what conditions is devaluation required to restore equilibrium
current account
when imports > exports
demand for $ > supply $
what are the effects of devaluation
current
increase in E
- imports are more expensive
- increases competitiveness of economy
- exporters receive more LCU per unit of exports - benefit from higher prices
on the capital account (inflows/outflow) side what is supply and demand
inflows = supply of $ (aid, FDI, borrowing)
outflows = demand for $ (debt servicing)
under what conditions is appreciation required to restore equilibrium
capital account
imports > exports
supply > demand
what are the effects of appreciation
capital
decrease in E
- bad for tradeable sector - reduced competitiveness + exporters harmed
- good for investors - their profits/assets convert to more $ and reduces cost of debt servicing
what are the effects of depreciation
capital
increase in E
- bad for current investors - value of assets generates fewer $
- good for new investors - can buy more LCU for each $
what happens when there is a current account deficit
demand for $ > supply of $
- shortfall met by capital inflows
- aid covers the deficit
- or the government can borrow/use reserves or even restrict imports
- reserves are used to help deficit
what happens when reserves deplete
- cant sustain deficit
- devaluation needed - abandon the ped
what is NER (E)
the price that equilibriates demand and supply for the balance of payments
what is RER
relate to relative pirces of tradeables and nontradeables
Pt = tradeable
Pn = non-tradeable
what is argument in favour of fixed ER
reduce MP discretion by imposing a need to restrict inflation
- supports more stable macroeconomic policy
- limits seignorarage = inflation tax
RER equation
Pn / Pt
Pn / EPt*
what Pt =
price of tradeables
- traded goods
what Pn
nontradeables price
- production costs
pt*
world price of tradeables
how does Pn relate to world prices Pt*
- if Pn is high comapred to gloabl levels = the country is relatively uncompetitive
- high production costs = not competitive
under a floating ER what happens to maintain RER
vs fixed
- E will adjust to maintain RER
fixed
* E cant change
what happens if domestic inflation is greater than world inflation
- real appreciation
RER increases
pn will increase = become less competitive
who should you adopt a fixed ER with
your major economic partner
trade and capital flows
