International Monetary Economics - Essay Example

One of the main fields of research which has attracted the attention of the researchers worldwide is the exchange rate and the trade balance relationship (Liew, Lim & Hussain, 2003, p.1). The elasticity model which is one of the most important models of balance of trade throws light on the prevalence of theoretical relationship between trade balance and rates of exchange of a nation (Stucka, 2004, p.22). There are a number of ways in which exchange rates can influence the trade balance of nations which provides valuable inputs to the nation’s policy makers to undertake exchange rate policies like devaluation policies etc in order to being about balance in the nation’s foreign trade.

Devaluation increases the prices of foreign currencies making imports more expensive in the home nation till the foreign suppliers reduce their prices in order to compensate (International monetary economics-a, n.d., p.4). The reason why countries devaluates is to attain a competitive position in comparison to its competitors through the reduction of prices of goods produced domestically below the level which is compatible with the purchasing power parity (International monetary economics-b, n.d., p.5). .

This would be followed by a critical analysis through the presentation of a critical literature on the above aspects through which it tries to present the impacts of exchange rates adjustments on the balance of payments of nations. The monetary approach This approach is based on the fact that the disequilibrium in the balance of payments is based on the monetary disequilibrium which is the difference between the amount of money that individuals want to hold and the amount of money that the monetary authorities supply.

In case the people want to hold more money, which exceeds the amount supplied by the Central Bank, then this would be met by a greater money inflow from abroad (Malik, 2006, p.2). The elasticity approach As per the views of Marshall, trade deficits lead to devaluation. Exports become more attractive in other nations. On the other hand the imports are made costlier in the domestic nation and this leads to the squeezing of the import bills. Trade deficits are thus eliminated in the process (Sharan, 2011, p.121). The traditional approach The traditional approach deals more with the current account or the trade balance of nations.

However, the approach does not consider the other components of the international accounts other than the current account. The balance of payments goes up along with the current account. However, since 1960s and the 1970s the traditional views have changed after studies emphasizing on factors determining the capital account flows (Arize, 2000, p.35). Critical Analysis Previous research reveals the importance of exchange rate fluctuations as a tool for international monetary regime. The comparison for seven of the largest non