Question

Discuss all the adjustments that occur for the following situations.

a.) If BCA + BKA < 0 and the currency floats freely, what can the government do to reduce or eliminate the deficit?

b.) How would your answer to a.) change if the currency is fixed?

c.) What might happen to BRA if the currency is fixed and there is a deficit? What does your answer imply for the foreign currency holdings of the deficit country?

d.) Does the BOP deficit narrow as a result of the central bank defending (via a fixed rate) an overvalued currency?

e.) If BCA + BKA > 0 and the currency floats freely, what can the government do to reduce or eliminate the surplus?

f.) How would your answer to d.) change if the currency is fixed?

g.) What might happen to BRA if the currency is fixed and there is a surplus? What does your answer imply for the foreign currency holdings of the surplus country?

h.) Does the BOP surplus narrow as a result of the central bank defending (via a fixed rate) an undervalued currency?

Answer 1

Part A

In this case, macroeconomic policies are not necessary because of the currency are a float so that the nations home currency will be weak, and the economic policies become independent.

Part B

If the currency is fixed, then there would be a need for both fiscal and monetary policies. The fiscal policy response is a higher tax, lower government spending and increased domestic interest. On the same way, the monetary policy actions by absorbing excess currency from the foreign exchange market. This action indicates when BRA>0.

Part C

Here the central bank should reduce the foreign currency dominated asset held by them.

Part D

The answer is No. because there is no change in private behaviour because the exchange rate is unchanged. It is the central bank action.

Part E

In this case, macroeconomic policies are not necessary because of the currency are a float so that the nations home currency will be weak, and the economic policies become independent.

Part F

If the currency is fixed, then there would be a need for both fiscal and monetary policies. The fiscal policy response is a lower tax, Higher government spending and reduces domestic interest. On the same way, the monetary policy actions by intervening the foreign exchange market and strengthen the demand for foreign currency. This action indicates when BRA<0.

Part G

Here the central bank should Increase the foreign currency dominated asset held by them.

Part H

The answer is No. because there is no change in private behaviour because the exchange rate is unchanged. It is the central bank action.