Question

With the demise of the Bretton Woods fixed exchange rate system, the major functions of the International Monetary Fund have been to both serve as a lender of last resort and also to help countries coordinate macroeconomic policies. Explain why macroeconomic policy coordination is important for the stability of exchange rates.

Answer 1

Excahnge rate is one the most important key factor through which a country's economic health is determined. It plays a pivotal role to a country which operate in free market economy. Its instability affects nation's trading relationship with other nations. A higher valued currency makes import less expensive and its exports more expensive in wor5kd market and vice versa. A higher exchange rate Can worsen a country's balance of trade while a lower exchange rate can be expected to improve it. Thats why the main focus of institutions like IMF is on macroeconomic policy of a country because exchange rate is affected by the following macroeconomic factor which are as follows: -

1. Inflation rates- if the inflation is low ,implies prices are lowwhich means rising value of currency as the relative purchasing power increases relative to other currencies. Those country with high inflation rate face depriciating valueif their currency.

2. Interest rate- increase in interest rate cause a country's currency to appreciate because higher interest rate provide higher rates to lenders there by attracting more foreign capital,which causes a rise in exchange rates.

3. Current account or BOP-cureent account reflects balance of trade between a country and its trading partners. A deficit in current account shows the country is spending more on foreign trade than it is earning.means they are borrowing capital from foreign sources to make up the deficit. The excess demand for foreign currency lowers the country's exchange rate untill domestic goods and services are cheap enough for foreign demand.

4 Public debts- a large scale deficit reflects that a country is engaged more in financing public sector projects while a large debt encourage inflation. The case may be that government may pay a large part of debt by printing money causing inflation. Of the government is not able to service its deficit through domestic ways then they will increase the supply of securities in foreign makret by lowering the prices.

5. Speculation - of the currency value is expected to rise investors will demand more of that currency q in order to make profits in near future . So value of currency will rise which will come with rise in the exchange rate also.

6.Political stability and performance of the economy - a political disturbances can cause a loss of confidence in the currency and a movement of the capital to currencies of more stable countries.

7.Terms of trade - tthis ratio is related to current accounts and balance of payments. if the price of a country's exports rises by a greater rate than that if its imports,then tot is improved .it indicates a rise in exports revenue ,which means increase in demand for country's currency value.

This all above indicate that a country's macroeconomic factor play crucial role in bringing stability in exchange rate of a country .that why institutions like IMF focus more on macroeconomic satbillsation as to maintain exchange rate