Question

In: Economics

Overvalued Exchange Rates: a) What is an overvalued exchange rate? Use a graph to explain. b)...

Overvalued Exchange Rates:
a) What is an overvalued exchange rate? Use a graph to explain.


b) Why are overvalued exchange rates unsustainable?
c) How do countries try to keep its exchange rate overvalued?

Solutions

Expert Solution

a) An overvalued exchange infers that a nation's cash is too high for the condition of the economy. The exchange rate implies that the nations fares will be generally costly and imports less expensive. It is the rate has a tendency to discourage household request and empower spending on imports. It is measured by purchasing power parity.

b) An overvalued exchange rate is particularly a problem during a period of sluggish growth. If the economy is booming, an overvalued exchange rate can help reduce inflationary pressure, but in a recession, an overvalued exchange rate can cause further deflationary pressures. That is why the rates are unsustainable.  An overvalued exchange rate discourages productivity growth because of the disadvantaged exports and imports sector. As overvalued exchange rate resulting in unsustainable current account deficit, increasing external debt and possible speculative attacks.

c) To maintain the exchange rate overvalued, Central bank provide the additional foreign currency that residents desire whereas changing the equillibrium position might eliminate the overvaluation problem.


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