1. Fixed (Pegged) vs Floating Exchange Rates

2. Fixing/Pegging the bople at 1bople=$2.00
 often in DISEQUILIBRIUM
eg. If 1 bople = 2 dollars
i.e. Undervalued OR Overvalued ? (consider motives and consequences of each)
Which is happening in this case ?
 need to use RESERVES Or get LOANS
to make Qd = Qs

3. Suppose reserves run out and cannot get loans from IMF or other central banks
Need to reduce …………. by ………………………….. 
OR  May decide to REVALUE /DEVALUE
(which is appropriate in this case?)

4. Floating: Market-determined/Market forces (
Example: Start at point A
with D1 and S
if a …………… on current account (and capital and financial account balanced)………………
Exchange rate ……………………………………..
 export prices ? And import prices ? the surplus……………..
No central bank or government intervention

5. Floating: Market-determined/Market forces
Example: Start at point D
with D and S1
if a …………… on current account (and capital and financial account balanced)………………
Exchange rate ……………………………………..
 export prices ? And import prices ? the deficit……………..
No central bank or government intervention

6. Pegged/Fixed Is the currency undervalued or overvalued?
What will the central bank/govt. need to do to keep it pegged?
Why would they choose to keep this peg?
If the central bank runs out of reserves, what would economic policy have to be?

7. Evaluation of a floating exchange rate
Advantages
1) automatically moves towards equil. In FOREX market
(never over- or undervalued)
2) Theoretically also Balance of Trade surpluses or deficits are automatically corrected
ASSUMING sum of PEDs>1
3) Do not need reserves
4) can have independent fiscal and monetary policies
Disadvantages
1) Fluctuations uncertainty for importers and exporters (BUT can use futures ex rate markets)
2) If Marshall-Lerner not fulfilled surplus/deficit WIDENS
3) Impact of international financial markets on the ex. rate. Eg Risk of “capital flight” depreciating ex rateneed reserves or loans

8. Evaluation of a fixed exchange rate
Advantages
1) Predictable (assists trade). (2)……???…speculation
3) …………..influenced by flows on the capital and financial accounts
4) Need not worry about ……….. Elasticities of demand for imports and exports
Disadvantages
1) Need large reserves
2) Often under-valued or over-valued
3) Domestic macro economic polices are………..
4) Can have ………………….
If speculators suspect that…………..

9. Managed float (“dirty floating”)
Theoretically freely floating, but occasional intervention by the central bank/government to influence the exchange rate.
Can respond to large shocks
Needs international cooperation and agreement---use the INTERNATIONAL MONETARY FUND
Needs reserves
NB (notice that)
Some currencies are pegged to the Euro or US $
Some currencies are not freely CONVERTIBLE if a person wants to change a large amount for “financial investment” he/she can be prevented from doing so by EXCHANGE CONTROLS regulated forex market and can prevent “capital flight”

10. Evaluation of changes Benefits vs Costs of
1) Appreciation/??valuation/ an ??????valued exchange rate
2) Depreciation/??valuation/ an ??????valued exchange rate

11. Summary of Appreciation vs Depreciation
Appreciation etc 
Depreciation etc
Winners=
BUT may encourage firms to become ……………..
Balance of trade?
BUT consider……….
Inflation vs Growth/Emp??
(Consider effects on AD and SRAS)
Transfers and income from overseas?
Cost of servicing (financing) international debt in terms of own currency is lowered
Risks?
Winners =
BUT firms which……………..
Balance of trade?
BUT consider……….
Inflation vs Growth/Emp??
Transfers and income from overseas?
Cost of servicing (financing) international debt in terms of own currency is ……………..
Risks?