The Exchange Rates Sphere of the Macroeconomic Arena - Assignment Example

The Exchange Rates Sphere of the Macroeconomic Arena The area that has been chosen for the purpose of this report is the exchange rates sphere of the macroeconomic arena. This has been done so because it is most easily one of the more tangible issues of macroeconomics i.e. issues that directly affect people and do so in a really short period of time and a basic understanding of this area is deemed necessary to understand macroeconomics in a better way. There are basically three types of exchange rates: a) Free Floating Exchange Rates: In this type of an exchange rate system the currency determines its value on the basis for the demand and supply of the currency on the international foreign exchange market. The exchange rates have a close impact on the exports and imports of the country because when people exchange goods across borders they want to be paid in their own currency and hence the need to exchange value and an exchange rate arises. There are certain benefits and certain disadvantages associated with each and every trade system and so does the free floating exchange rate, the free floating exchange rate is the basis of uncertainty in the economy because there are no blockades at any end for the free floating exchange rate to be limited, it fluctuates rapidly and hence the environment for trade and investment is not a very feasible one. Another added disadvantage of this type of this kind of an exchange rate is the element of speculation. The advantage of the exchange rate system is that it balances the balance of payments and the governments do not have to worry in this regard. b)Dirty Floating: dirty floating, as the name implies is managed exchange rate systems, these systems are managed by the central bank of the country and it basically determines boundaries within which to keep the exchange rate value, if the rate crosses the maximum value then the central bank supplies more into the market so that the rate falls down and when it rises exactly the opposite happens. The advantage of having such an exchange rate system is that it adds a lot of certainty to the trading and the investment procedures and cracks down on speculative measures. The disadvantage of this system is basically to the government because it has to take measures to control the whole system and also the added responsibility of the balance of payments falls squarely on to the shoulders of the present government. c) Fixed exchange rates: In this type of exchange rate systems the rate is fixed at one point and the government should be ready to buy and sell as soon as there are any changes in the market for the currency. The disadvantage here is the obvious one of keeping the exchange rates at such a fixed position and in order to do so the government would have to tinker with its foreign exchange reserves which is not at all an encouraging thing to do at all, to say the least. Section 2 As the graph above indicates that the value for the dollar against other currencies has been falling consistently because of the aftermath of the world trade centre tragedy. The dollar has fallen by 15% against the Euro, 18% against the Australian dollar and 21% against the pound. The current exchange rate in the foreign exchange market for the dollar against the pound is $2.06:1.00 pound. United States Of America is one of the largest, if not the largest, oil consumer in the world and hence after the 9/11 when the oil prices have risen continuously, more and more dollars have to be paid to sustain the growth and development of the country and hence as a result the economy has been under pressure and the rise in petrol prices have caused an increase in supply of the dollars in the foreign exchange market causing the value to fall in comparison with other countries currencies. Oil prices are currently pretty stable at the moment around the $60/barrel mark. Section 3 The need to delve into the reason why this has happened to the dollar is perhaps the most important question of all. The reasons that have been identified in the article and some through ones own intellectual arguments are: a) Low over seas demand for corporate debt: The demand for the US dollar has fallen considerable because this was one of the most major demand factor of the US dollar, but now since people have not been wanting any corporate loans the demand has fallen considerably and this has adversely affected the standing of the US dollar in the foreign exchange market. b) Housing sector: Americas housing sector has been a drag on the economy for a long time now and the affects have begun to show on the currency exchange rates now. c) Oil Prices: As stated above oil prices after the 9/11 have played an very important role in toppling the greenback from a very powerful position. The increasing oil prices have damaged the balance of the demand and supply schedule of the dollar because excessive dollars have been supplied into the market to sustain the growth and development in the US economy. Section 4 Though the current situation of the dollar is a cause of concern for the people handling the economy of the United States Of America but when one views it on the larger scale the picture does not look that intimidating. The countries that have gained in comparison to the dollar have foreign debts and deficits as well, Australia’s deficit on the current account has been much more persistent than that of the USA and the foreign debts ratio to its GDP was a whopping 60%. Other countries do have their necks deep in foreign debts, with New Zealand’s ratio being as high as 90% where as the US ration is only 19% and this is a very encouraging positive sign. This means that all is not yet lost on the dollar and the picture is not as bleak as it seems. References 1. "Soft Currency." Economics Focus 26th July 2007: 2. Nordhaus, Samuelson. Economics. seventeenth. 1999. 3. Stan lake, John. Introductory Economics. 6th. 1996 4. Blanchard, Oliver. Macroeconomics. 1998. 5. Krugman, Paul. International Economics: Policy and Theory. 6th. 2000 Read More