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Globalization and exchange rate policy (Politics & exchange rate…
Globalization and exchange rate policy
Politics & exchange rate
(Currency policy is made in an intensely political environment. Even apparently apolitical observations often embody political assumptions or assertions)
Optimal currency area criteria
Currency union between two coun- tries is welfare-improving where factors are mobile between them, or when the countries are subject to correlated exogenous shocks, or when their economic structures are very similar
Currency as an anchor for inflation expectations
Emphasizes the use of the exchange rate as a way of overcoming the time-inconsis- tency of monetary authorities’ anti-inflationary commitments. A government attempting to signal its seriousness about non-inflationary policy can peg the exchange rate to a nominal anchor currency
Choices and tradeoffs
Regime
(Fixed or floating: stability and credibility or policy flexibility?)
Fixed
(monetary and currency stability)
Floating
(Policy flexibility)
Level
(High or low: consumers or producers?)
A strong (appreciated) currency
gives residents greater purchasing power, but the fact that it makes foreign products relatively cheaper also subjects national producers of trade- able products to more foreign competition.
A real depreciation
stimulates demand for locally produced tradeable products, which is good for their producers; but it makes consumers worse off by raising the prices they pay for foreign goods and services.
Political factors in the determination of current policy
Special interest groups
(heavily involved in foreign trade and investment)
Favor exchange rate stability, since currency volatility is an everyday concern that makes their business riskier and more costly
Care less about a loss of national monetary autonomy, since they typically do business in several countries, and can shift their business or assets abroad if domestic conditions become unfavorable
Governments
(face pressures)
For reduced volatility, from those who are internationally exposed, includ- ing export producers and those with foreign exchange liabilities, such as firms with dollar debts (suggesting a desire for a fixed exchange rate)
For favorable relative price effects, especially from tradeables producers (suggesting a desire for a depreciated currency, hence floating)
For purchasing power, from consumers (suggesting a desire for an appre- ciated currency)