1. International Economics
16/11/61
Session 23
Internal and External Balance with Fixed Exchange Rates
Aj.Noom Tel

2. Benefits of Fixed Rate Helps reduce Inflation Helps reduce uncertainty
 For example, if a firm is exporting to the US, a rapid appreciation in the domestic currency would make its exports uncompetitive and therefore may go out of business.

3. Defending against Depreciation
New Spot Rate
S1$ D$
Dollars need to be sold
Excess Demand

4. Defending against Appreciation
Dollars need to be bought
Excess Supply
S1$
New Spot Rate D$

5. Money Supply & the Balance of Payment with Fixed Rate
Government sell domestic currency
Capital flows out to other countries offering higher interest rate
There are a lot of competitions among the banks
When income rise, people tend to buy more importing products.
When price level increase, foreign customers will buy less domestic products.
For a decrease in the money supply, reverse the direction of all changes.

6. Payments Adjustments for a Surplus Country with Fixed Rates
When the domestic money is supplied, people do not need to hold money.

7. Expansionary Fiscal Policy & the Balance of Payment with Fixed Rate
For contractionary fiscal policy, reverse the direction of all changes.

8. Foreigners buy more domestic currency than its need (Less domestic currency in the system) Government have to sell its own currency
Foreigners buy less domestic currency than its need (More domestic currency still in the system) Government have to buy its own currency.

9. Employment & Fixed Exchange Rate
The government achieve both full level of employment and the balance of payments
Easy fiscal policy (The government spends more budgets)
Tight monetary policy by buying the domestic currency back. ( As the domestic currency is less, the interest is higher; the need to hold the money is greater.)
What would happen if the scenario is different from this ?

10. Perfect Capital Mobility
This happens to a small country that cannot influence global financial markets by itself.
The defense of fixed exchange rate will not impact on the interest and the domestic production.
The interest rate depends on the global interest.
For FE curve, any interest rate above or below 6% will impact on the capital inflows to this country, but will not influence the domestic product.
For LM curve, any interest rate above or below 6% will impact the need to hold the currency of this country, but will not influence the domestic product.
For IS curve, the shift of the curve has an effect on the domestic product, but no effect on the interest rate.