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B BALANCE ALANCEOF OFP PAYMENTS AYMENTSAND ANDEXCH ANGE EXCHANGERATE RATE: :


Elasticity of demand for exports and elasticity of demand for imports will deter
mine the relation b/w BoP and exchange rates. If there is persistent deficit in
BoP,
international confidence on currency will
be eroded and causes exchange rate to
fall.
Moreover, the output capacity and the
level of employment in the domestic
economy might influence the BoP,
because if the domestic economy has full
employment already, it will be unable to
increase its volume of production for
exports
5. 5.S SPECULATION PECULATION: : Traders as well as investors of capital might c
arry speculation in a currency. â ¢ When a currency is expected to
devalue, debts are paid slowly in
the hope that the exchange rate
may fall, giving an advantage to
them to pay off their debts, as
currency becomes cheaper.
â ¢ Debtors owing money in a currency,
which is expected to appreciate in
value, may try to pay off their debts
before the currency becomes
expensive, giving them financial
disadvantage.
Speculation may be act: I I. . A AS SA ASTABILIZING STABILIZINGF FACTOR ACTOR: :
In case of deficit, there is
downward pressure. If speculators
considered deficit temporary, they
might purchase assets in the
currency when there is Bop deficit
and sell them, perhaps at a small
profit, when there is surplus.
II II. . A AS SA ADESTABILIZING DESTABILIZINGF FACTOR ACTOR: : If speculators cr
eate such a high
volume of demand to buy or sell
currency that exchange rate
fluctuates to levels where it is
overvalued or undervalued, so
speculation can pose a destabilizing
effect on the health of economy
because uncertainty about the future
exchange rates will deter FDI.
6. 6.G GOVERNMENT OVERNMENTI INTERVENTIONS NTERVENTIONSIN INF FOREIGN OREIGN E E
XCHANGE XCHANGEM MARKETS ARKETS: : I I. . D DIRECT IRECTM MEASURES EASURES(O (OF
FICIAL FFICIALOR OR U UNOFFICIAL NOFFICIAL): ): â ¢ Open Market Operations i.e. sellin
g or buying of currency. II II. . I INDIRECT NDIRECTM MEASURES EASURES: : By cha
nging domestic interest rates to: â ¢ Attract financial investment by raising interest
rates. â ¢ Discourage financial investment by lowering interest rates. ______________
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E EXCHANGE XCHANGER RATES ATESP POLICIES OLICIESOF OFG GOVERNMENTS OVERNMENTS: :
1. 1.F FIXED IXEDE EXCHANGE XCHANGER RATES ATES: : It is a policy of extremely
rigid fixed
exchange rates in which every
Government must use its official
reserves to create an exact match b/w
supply and demand for its currency in
the FOREX markets, in order to keep
the exchange rate unchanged. Using
the official reserves will thus cancel
out a surplus or deficit on the current
account and non-official capital
transactions in their BoP.
â ¢ A BoP surplus would call for additions to the official reserves. â ¢ A BoP deficit woul
call for drawings on official reserves. The official reserves could consist of
any currency or gold within the FOREX
Agreement.
A ADVANTAGES DVANTAGESOF OFF FIXED IXEDE EXCHANGE XCHANGER RATE ATE P POLICY OLI
CY: : i. Removes uncertainty, thus encourage international trade. ii. Imposes ec
onomic disciplines
on countries in deficit or
surplus.
D DISADVANTAGES ISADVANTAGESOF OFF FIXED IXEDE EXCHANGE XCHANGER RATE ATE P POLI
CY OLICY: : i. This policy restricts
independence of domestic
economic policies.
ii. High inflation forces a country
to devalue in order to make its
exports competitive and
imports cheaper.
2. 2. 3. 3.F FREE REEF FLOATING LOATINGE EXCHANGE XCHANGER RATES ATES: : Exchang
e Rates are left to the free
play of market forces and there is no
official financing at all. There is no
need for the Government to hold any
official reserves, because it will not
want to use them.
U USAGE SAGE: : Floating Exchange Rates is the only option available to the Gove
rnment when all other systems break down and fail. 4. 4.M MOVABLE OVABLEP PEG EG
: : A Movable or adjustable peg system is
a system of fixed exchange rates, but
with a provision for the devaluation or
revaluation of currency.
A ADVANTAGES DVANTAGESOF OFM MARGINS ARGINSAROUND AROUNDA AMOVABLE MOVABLE PEG P
EGSYSTEM SYSTEM: : A movable peg system provides
some flexibility. Exchange rates,
although fixed, are not rigidly fixed,
because adjustments are permitted.
D DISADVANTAGES ISADVANTAGESOF OFM MARGINS ARGINSAROUND AROUND M MOVABLE OVABLEP
PEG EGSYSTEM SYSTEM: : It is still fairly inflexible, because
Governments only have the choice
b/w a revaluation/devaluation or
holding the exchange rate steady.
5. 5.M MARGINS ARGINSAROUND AROUNDM MOVABLE OVABLEP PEG EGS SYSTEM YSTEM: : A mo
re flexible Movable Peg system
would allow some minor variations in
exchange rates.
5.M MANAGED ANAGEDF FLOATING LOATINGE EXCHANGE XCHANGER RATE ATE S SYSTEM YSTEM:
: It is the most prevalent exchange rate system today. In this system, a countr
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