International Economics Floating Exchange Rates and Internal Balance 20/09/54 Session 24 Floating Exchange Rates and Internal Balance Aj.Noom (anuphak@gmail.com/0835426434)

Advantages of Floating Rates Flexibility Lower foreign exchange reserves

Expanding the Money Supply with Managed Floating Exchange Rates There will be more domestic money in the system since foreigners will sell the domestic currency to buy other currencies. Therefore, this will result in domestic currency depreciation (i.e.,from ฿25/$1 to ฿30/$1). For a decrease in the money supply, reverse the direction of all changes.

The need to hold the domestic currency decrease. The need to invest increase.

Effect of Expansionary Fiscal Policy with Floating Exchange Rates There will be less domestic money in the system at first since the foreigners will sell other currencies to buy the domestic currency. Therefore, this will result in domestic currency appreciation (i.e.,from ฿25/$1 to ฿20/$1). Sooner or later, since the domestic price level will increase continually, there will be less demand for the domestic currency which then results in the depreciation of the domestic currency (i.e.,from ฿20/$1 to ฿30/$1). For contractionary fiscal policy, reverse the direction of all changes.

Free Floating Exchange Rates Managed Floating Exchange Rates (The LM curve is fixed for the ease of understanding)