ECON 102 1st Edition Lecture 35 Outline of Last Lecture 1 Open Economy Part II a Exchange Rates b Exchange Rate Policies Outline of Current Lecture I Open Economy Part III a Exchange Rate Regime Dilemma b Floating Exchange Rate i Expansionary Vs Contractionary c International Business Cycle Current Lecture Exchange rate policy poses a dilemma There are economic payoffs to stable exchange rates but the policies used to fix the exchange rate have costs Exchange market intervention requires large reserves and exchange controls distort incentives If monetary policy is used to help fix the exchange rate it isn t available to use for domestic policy A de valuation is a reduction in the value of a currency that previously had a fixed exchange rate Devaluation is a special type of depreciation Devaluation US Imports Exports A revaluation is an increase in the value of a currency that previously had a fixed exchange rate Revaluation is a special type of appreciation Revaluation US Imports Exports Under floating exchange rates expansionary monetary policy works in part through the exchange rate Cutting domestic interest rates leads to a de preciation and through that to higher exports and lower imports which increases aggregate demand Contractionary monetary policy has the reverse effect These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute In the graph below it is shown what happens in the foreign exchange market if Genovia cuts its interest rate as explained in the bubbles on the graph EX Genovian Situation The fact that one country s imports are another country s exports creates a link between the business cycle in different countries Floating exchange rates however may reduce the strength of that link
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