Mundell Flaming Model

Central banks intervene in foreign exchange markets by “influencing the monetary funds transfer rate of a nation’s currency” with the purpose of building reserves, keeping the exchange rate stable, to correct imbalances, to avoid volatility and keep credibility. It implies changing the value of a currency against another one. It creates demand or supply of a currency by buying or selling the country’s currency in the foreign exchange market. (Foreign Exchange Intervention)

The _____________ is a market for converting the currency of one country into that of another.

Currency exchange rates can be categorised as floating, in which case they constantly change based on a number of factors, or they can subsequently be fixed to another currency, where they still float, but they additionally move in conjunction with the currency to which they are pegged. Floating rates are a reflection of market movement, demonstrating the principles of both demand and supply, as well as limit imbalances in the international financial system. Fixed exchange rates are predominantly used by developing countries as they are preferred for their greater stability. They grant further control to central banks to set currency values, and are often used to evade market abuse. (MacEachern, A. 2008; Simmons, P.

Currency intervention is the action of one or more governments, central banks, or speculators that increases or reduces the value of a particular currency against another currency – this is according to Wikipedia.

Though there are additional models such as the demographic, environmental, political and governmental models, what is seen in today’s model market are the economical and social models. These models

A country such as China might choose to peg their currency to the U.S. dollar to keep prices stable for a key trading partner like the U.S. If the U.S. dollar would appreciate considerably against most currencies, this would not affect China trade with the U.S., but Chinese goods would become more expensive to their other trading partners, and could cause Chinese exports to these other markets to decrease.

A country such as China might choose to peg their currency to the U.S. dollar to keep prices stable for a key trading partner like the U.S.  If the U.S. dollar would appreciate considerably against most currencies, this would not affect China trade with the U.S., but Chinese goods would become more expensive to their other trading partners, and could cause Chinese exports to these other markets to decrease.

The long-run equilibrium of the economy is found where the aggregate-demand curve crosses the long-run aggregate-supply curve (point A). When the economy reaches this long-run equilibrium, the expected price level will have adjusted to equal the actual price level. As a result, the short-run aggregate-supply curve crosses this point as well.

Refer to the sets of the aggregate demand, short-run aggregate supply, and long-run aggregate supply curves. Use the graphs to explain the process and steps by which each of the following economic scenarios will shift the economy from one long-run macroeconomic equilibrium to another equilibrium. Under each scenario, elaborate the short-run and long-run effects of the shifts in the aggregate demand and aggregate supply curves on the aggregate price level and aggregate output (real GDP).

This represents a rightward shift of the demand curve from D1 to D2 and results

When monetary authorities have not insulated their domestic money supplies from the foreign exchange transactions, it is known as ________ intervention.

Assuming U.S. goods and foreign goods are substitutes, more demand for American goods creates more demand for U.S. currency. More demand of the U.S. currency relative to the demand of the foreign currency due to a given market force (let’s say for example economic growth in U.S) will cause the U.S. dollar to appreciate. Therefore, the U.S. dollar appreciates as demand for U.S. dollar increases from foreigners, and at the same time, the foreign currency depreciates as they supply more of foreign currency to purchase U.S. dollars. This is illustrated by the graph

(Wright and Quadrini, 2009, p. 221) In order to influence the Foreign exchange rate a country will perform an unsterilized foreign exchange intervention, subsequently, these transactions will influence the FX rate exchange because they influence the monetary base. The reasons for interventions vary, but one is to stabilize the FX exchange rate. An example of a unsterilized transaction would be if a Central Bank bought $50 million Foreign international reserves. It would increase foreign international reserves and the monetary base. In contrast, there is a sterilized transaction in which the Central Bank which should not have a long term impact on the Foreign exchange rate. To offset the purchase of the $50 million Foreign reserves it might sell $50 million domestic bonds. (Wright & Quadrini, 2009, p.

dollar. In dollarization, the country abolishes its own currency and uses a foreign currency, such as the U.S. dollar, for all domestic transactions. 6. Emerging market exchange rate regimes. High capital mobility is forcing emerging market nations to choose between free-floating regimes and currency board or dollarization regimes. What are the main outcomes of each of these regimes from the perspective of emerging market nations? There is no doubt that for many emerging markets a currency board, dollarization, and freely-floating exchange rate regimes are all extremes. In fact, many experts feel that the global financial marketplace will drive more and more emerging market nations towards one of these extremes. As illustrated by Exhibit 2.5, there is a distinct lack of “middle ground” left between rigidly fixed and freely floating. In anecdotal support of this argument, a poll of the general population in Mexico in 1999 indicated that 9 out of 10 people would prefer dollarization over a floating-rate peso. Clearly, there are many in the emerging markets of the world who have little faith in their leadership and institutions to implement an effective exchange rate policy.

Despite this, however, some have since suggested that their model is pure economics, and is only valid in a theoretical world that doesn’t reflect some of the frictions that actual financial markets do.