Question

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Changes in the value of a nation’s currency affect the nation’s net exports, and thus GDP. How might this make a large country, like the U.S., more willing to adopt a flexible exchange rate regime than a small country, like Belgium.

.Criteria

why do large countries, like the U.S., typically have a lower portion of their GDP as exports and imports, than a small country like Belgium ?

How does the size of a nation’s trade sector affect the stability of its GDP?

How do exchange rate fluctuations affect a nation’s GDP?

Why might a large country be more willing to adopt a flexible exchange rate than a small country would?

Write up your analysis using correct language, explaining all your work

Answer 1

The larger the country, more is the GDP of that country as the population is greater, plus US is a global economy whose GDP is far greater than that of Belgium. This leads to more trade opportunities and people investing extensively in U.S, but as the GDP growth doesn't extensively rely on trade, more is the need to maintain a flexible exchange rate regime as it proves easier to import and export goods and services. Belgium on the other hand would be trading in certain components with specific countries and the scale of the trade would be greater with respect to its GDP which does complicate matters and makes it necessary for it to adopt fixed exchange rate regime where there is no extensive currency volatility.

In large countries such as U.S, private consumption is the main driver of GDP as people consume extensively, as this component drives up GDP, exports and imports constitute a comparatively smaller share. Thus the main crux is that larger economies depend less on external economies to drive growth or to satisfy domestic demand as they have enough domestic industries to satisfy local demand of goods and services. Belgium on the other hand would have a higher share as they have to rely on external economies to drive growth, as they are not self sufficient on their own because they have a set climate which is not able to grow certain produce.

If the size of the nation's trade sector is large and constitutes a major component of the GDP than external factors reduce the stability of the GDP as the GDP is driven because of growth in other countries, whereas if a country is self reliant and its domestic demand is met locally from locally produced goods and services, than its output grows much faster and external factors do not affect the stability of the GDP as GDP is not being driven by that. Thus more the size of a nation's trade sector in GDP, more it affects the stability of the GDP.

Exchange rate fluctuations wherein the currency depreciates leads to imports turning expensive or driving more exports, which leads to trade balance worsening and impacting the GDP when the country has to spend more on imports, thus reducing the total gains which it achieves via exports, which reduces GDP which consists of net exports (exports-imports). On the other hand when currency appreciates, the exporters earn less and exports decline and imports turn cheap, which leads to less gains as net exports might also turn negative. Declining the GDP further.

Thus as the larger country has more trading partners and more economies of scale, it would be more willing to adopt a flexible exchange rate than a small country. Plus smaller economies have greater share of trade in generating output, to reduce the volatility which could be caused by the flexible exchange rate, the smaller countries opt for fixed exchange rate/pegged exchange regime as their GDP is driven by trade and any volatility can increase economic crisis wherein it will have to borrow more just because of speculation in the currency and volatility which could prove detrimental.

OECD library, World bank.