Module 18.3: Managing Exchange Rates Flashcards
What is formal dollarization?
When a country does not use it’s own currency and the currency of a different country. Does not create its own monetary policy.
What is the monetary union and what does it mean for domestic policy?
Individual countries give up the ability to create domestic monetary policy, but all participate in determining the monetary policy for the union.
What is a currency board arrangement?
an explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate. There may be some latitude to affect interest rates over the short term.
What is a conventional fixed peg arrangement?
A country pegs its currency within margins of another currency by selling and buying foreign currencies.
What is a crawling peg?
the exchange rate peg is adjusted periodically, typically to adjust for higher inflation versus the currency used in the peg.
What are managed floating exchange rates?
the monetary authority attempts to influence the exchange rate in response to specific indicators such as balance of payments, inflation rates, or employment.
What is the elasticities approach to understanding how a change in exchange rates affects a county’s balance of trade?
focuses on the impact of exchange rate changes on the total value of imports and the total value of exports.
What is the absorption approach to understanding how a change in exchange rates affects a county’s balance of trade?
focuses on capital flows. if the trade deficit is negative, that means that total savings is less than domestic investment in physical capital (surplus in the capital account).
What is the Marshall-Lerner condition? What is the formula?
used to understand the affect of domestic currency depreciation will decrease a trade deficit.
Wx * Ex * Wm * (Em - 1) > 0
Wx = proportion of total trade that is exports Wm = proportion of total trade that is imports Ex = absolute value of price elasticity of demand for exports Em = absolute value of price elasticity of demand for imports.
Formula is reduced to Ex + Em > 1, when import expenditures and export revenues are equal.
When will currency depreciation have a greater effect on the balance of trade?
when the goods being imported or exported are primarily luxury goods, goods with close substitutes, and goods that represent a large proportion of overall spending
What is the j-curve effect?
when a currency begins to depreciate the effect in the trade balance is negative, but increases over time as importers / exporters begin to adjust quantities.
What is the shortcoming of the elasticities approach?
it ignores capital flows, which must also change as a result of currency depreciation that improves the balance of trade.
What is the absorption approach formula?
BY = Y - E
Y = domestic production of goods & services E = domestic absorption of goods & services, which is total expenditure BT = balance of trade.
