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Fixed Exchange Rates
How do you maintain a fixed exchange rate?
Use of reserves:
Trade policies:
Domestic macroeconomic adjustments:
Exchange Controls and Rationing: U.S. government could handle the problem of a pound shortage by requiring that all pounds obtained by U.S. exporters be sold to the Federal government. --> then, the government would allocate/ration this short supply of pounds among various U.S. importers, thus restricting the value of U.S. imports to the amount of foreign exchange earned by U.S. exports.
Major Objections to exchange controls:
1. Distorted Trade
2. Favoritism
3. Restricted Choice
4. Black markets
Use of reserves:
- Currency interventions: Using official reserves to manipulate the market.
- Foreign currency and gold can be sold.
- For example: The dollar has depreciated relative to the pound. The US can sell its reserves of pounds to shift supply of pounds to the right and restore the exchange rate.
- The US could also sell gold to Britain to obtain pounds, and then sell the pounds for dollars.
- By selling the foreign reserve, the country can increase the supply of the currency and shift out the supply curve
- Important: If persistent deficits occur, the reserves may be exhausted and/or the fixed exchange rate will fail.
- Also, with a fixed exchange rate, the amount of government intervention is large. Every fluctuation needs government attention and correction.
Trade policies:
- To maintain fixed exchange rates, a nation can try to control the flow of trade and finance directly by discouraging/encouraging imports/exports through new tariffs and import quotas or special taxes and subsidies.
- Fundamental problem: this reduces the volume of world trade and creates inefficiency
Domestic macroeconomic adjustments:
- Use of monetary and fiscal policy to eliminate the shortage of foreign currency
- High interest rate from contractionary policy reduce total spending in the US--> reduce imports--> reduce demand for foreign currency
- Higher interest rate also encourages foreign investment--> increased demand of US Dollar; foreign currency depreciates--> reduce demand for foreign currency
Exchange Controls and Rationing: U.S. government could handle the problem of a pound shortage by requiring that all pounds obtained by U.S. exporters be sold to the Federal government. --> then, the government would allocate/ration this short supply of pounds among various U.S. importers, thus restricting the value of U.S. imports to the amount of foreign exchange earned by U.S. exports.
Major Objections to exchange controls:
1. Distorted Trade
- Like tariffs, quotas, and trade controls, exchange controls would distort the pattern of international trade away from the pattern suggested by comparative advantage.
2. Favoritism
- The process of rationing scarce foreign exchange might lead to government favoritism toward selected importers or lobbyists
3. Restricted Choice
- Controls would limit freedom of consumer choice
- Example: Even though some U.S. consumers may prefer Volkswagens, they may have to buy Chevrolets if the government limited imports. As a result, a limit placed on imports would impair business opportunities for some U.S. importers
4. Black markets
- Shortage of certain needed imported goods encourage black market operation
- Example: Black markets in China such as Hua Ting and Xiang Yang mainly supply western goods. The short supply of real western goods in China has encouraged widespread as well as popular black markets, showing the need in a society for more western goods.
CalebLiao |
Latest page update: made by CalebLiao
, Apr 29 2008, 8:31 AM EDT
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