History Shows Us That Attempts to Fix Exchange Rates or Create Monetary Unions Between Different Countries Usually End in Failure. Therefore, We Should Not Be Surprised by the Current Problems in the Euro Zone.

Thus the rationale behind changing the nominal exchange rate under a fixed or pegged exchange rate system is easy to follow provided that the set rate is found to be far away from the optimal or equilibrium rate. However, why does the central bank need to manage exchange rates which are determined by market forces in case of independent floating? This remains a contentious issue. Essentially, the central bank is believed to determine the appropriate level (or path) of the nominal exchange rate and then intervene in foreign exchange markets to bring the actual exchange rate close to the appropriate level. In practical sense, the appropriate level of the exchange rate may represent the rate which, when translated into a real exchange rate, is consistent with the long-run equilibrium real exchange rate. Many economists of neoclassical persuasion believe that the market determined exchange rates broadly represent the long-run equilibrium exchange rates and there is no need for managing exchange rates or intervention in foreign exchange markets.

Monetary policy, ‘The government’s policy relating to the money supply, bank interest rates, and borrowing’ (Collin: 130), is another tool available to the government to control inflation. Figure 4 shows, that by increasing the interest rate (r), from r1 to r2, the supply of money (ms) is reduced from Q1

Such a process can be very time consuming and imprecise, without, of course, having a market currency price to begin with. The exchange-rate system is an important topic in international economic policy. Policymakers and journalists often seem to treat the choice of exchange-rate system as one of the most important economic policy choices that a national government makes, on a par with free international trade. Under most circumstances and for most countries, a system of freely floating exchange rates is likely to be a better choice than attempting to peg the exchange rate.

By increasing or reducing the nominal interest rates, the money supply is either increased or reduced. When the rate goes up, people are not able to borrow, thus the money does not enter into circulation. But when the rates go down, people borrow in big numbers therefore increasing the money supply. So the monetary authority just needs to adjust the interest rates either upwards or downwards, and in-direct results will be reflected on the money on circulation.

The well-known economist, Joseph E. Stiglitz, stated in his recent book “the Euro” that the European single currency had been “flawed from its beginning” (Stiglitz, 2016). But what exactly are the problems the Eurozone is facing? In the following, the problems regarding the single currency and its consequences will be discussed.

Combine with the first order derivative of the Lagrange function, we can obtain a few functions which could link the exchange rate with a price level, consumption, and interest rate. We focus on the case that the current account is always zero. A zero current account for a small open economy and the rest of the world imply that〖 C〗_t^*=Y_t^*-G_t^*; and C_t Q_t^((1-α)/α)=Y_t-G_t. With all the results we can express the equilibrium condition in logs. Price setting as a

In the following content, we will mainly focus on four aspects of the flexible-price monetary model of exchange rate determination. To begin with, we are going to talk about the logic behind the

A country’s dominance in world trade, its status as the leading creditor and exporter of capital, initially underwrites its emergence as international money. The use of the currency of a country as the international reserve was both a logical outcome and a necessary basis of the development of capitalist internationally and the tremendous concentration of capital and trade flows in the hegemonic country. However, the perpetuation and preservation of its dominant role does not depends on its continued ‘creditor’ status but rather on its ability to attract and recycle capital from the rest of the world, while incurring a growing debt burden. It has to be the ‘borrower of last resort’. The imperative of maintaining international liquidity and maintaining sufficient global reserves depends on the ability of the country issuing the international money to sustain a deficit without eroding its status as a reserve currency.

The introduction of the euro will have important implications not only for the Union and its Member States but also for their partners. But while it will be a major event for international monetary relations and the international monetary system, there will be no abrupt change; nor is it likely to be destabilizing.

It is important to understand how the European Monetary System works, because the world is becoming highly globalized. Not only are businesses using trade, but consumers are dabbling into the consideration of buying products straight from other countries. Knowing how Europe’s currency, political and economic system works can help other countries better participate in trade. But because of the size of the European Union, it has become a difficult task to bring all those European nations to operate in unison. Europe is made up of more than 30 countries that have even more varieties of different cultures. Bringing these different cultures and systems together has been a long process over time that is continuing to develop.

‘Compensation Theory’ proposed by Lavoie and Wang can chip in as a better substitution for the problem at hand. According to this view, a central bank is able to offset a rise in the money supply by different operations on its balance sheet other than inverted open market operations. Thus a direct consequence of this can be inability to increase money supply through acquisition of net foreign assets which will therefore leave the price level unaltered. This theory is of the view that central bank’s compensation of net foreign assets growth is disjoint from the changes in the price level. These changes are more dependent on credit than on money.

The countries central bank maintains a fixed parity through direct intervention in the foreign exchange markets, for this reason the central bank must hold large reserves of foreign currency so as to mitigate the changes in supply and demand of their currency. If demand for a currency were to increase the exchange the central bank would have to sell enough of that currency in exchange for their own, to meet demand and maintain the exchange rate. A countries central bank is also able to maintain their exchange rate peg indirectly through the use of interest rate policy, imposition of foreign exchange regulations or intervention by other public institutions.

Q3.Exhchange rate is the value of one currency toward another. In case if the currency of pound for instant decrease (weaken), therefore, all their export of goods will become cheaper. On the other hand, if UK want to import from outside USA they have to pay more to import products and services. When the services and product of UK is cheaper than the United States, therefore, it will arm wrestle UK to increase export volume. Which will lead to have a surplus of international balance of payment. In return the other country which import goods from UK will focus on importing cheaper goods than exporting which will lead to a deficit to their international balance of payment. For example in 2011 the value of £1 = $1.65 which it means the value of pound decreased, which leads to import goods from UK really expansive and also traveling outside, with that the exporting was the best option for outside countries like US to buy a cheap goods from UK.

Developing countries are not worrying about the currency movements, they often plan to use the fixed rate system should limit the speculation and provide a stable system to allow importers, exporters and investors. A central bank ability limits the fixed rate system which the interest rate adjust the desirable for economic growth. When a Currency becomes over valued or undervalued this system adjust to prevent the market. If the currency is under pressure this system reserve to support by the effective management.

Explain how the international trade flows should initially adjust in response to the changes in inflation (holding exchange rates constant). Explain how the international capital flows should adjust in response to the changes in interest rates (holding exchange rates constant).