CHAPTER 21

FLEXIBLE EXCHANGE RATE

- trip na ma-reduce ng trade deficit or get out of recession, monetary expansion
. shift down, decrease interest rate, decrease exchange rate (depression)
FIXED EXCHANGE RATE
- hindi niya nako-control
- mas attractive ang flexible kasi nako-control mo yung exchange rate at interes
t rate
- MEDIUM RUN: nawawala ang difference between flexible and fixed
- EQUATION: real exchange rate = nominal exchange rate (domestic currency/foreig
n currency)
- pwedeng magbago ang real exchange rate through the nominal exchange rate and t
he foreign price level. sa nominal exchange rate, applicable lang siya sa flexib
le. pero yung foreign price level, ito ang nagbibigay ng change sa fixed.
AGGREGATE DEMAND
- OUTPUT: inverse sa exchange rate, direct sa government spending, inverse sa ta
xes
- sa isang closed economy, you have the control of altering your interest rate b
y changing the money supply. kaso sa fixed exchange rate, hindi na siya applicab
le. una, monetary policies are not applicable anymore. pangalawa, domestic inter
est rates are dependent on the foreign interest rates. kaya, EXCHANGE RATE ang g
inamit na variable.
- Price levels and outputs have negative relation.
- CLOSED ECONOMY: price level affects the real money stock (negative) and the in
terest rate (increase)
- OPEN ECONOMY: price level affects the exchange rate. mas mataas ang exchange r
ate, lower output
EQUILIBRIUM IN SHORT RUN AND MEDIUM RUN
- Aggregate supply relation is still the same. Walang pagbabago.
- REFRESH YOURSELF; CHAPTER 7
- SHORT RUN: nominal exchange rate = real exchange rate (FIXED EXCHANGE SCENARIO
WW)
- MEDIUM RUN: real exchange rates move due to price level kahit na nominal excha
nge rate is fixed
- note: yung pagbaba ng price level (in order to be equal to the natural rate of
output), ang assumption non is that the foreign price level is constant. kapag
nagbabago ang foreign price level, dapat e mas maliit ang increase ng domestic p
rice level kesa sa foreign price level para bumaba ang exchange rate hehehe
DEVALUATIONS
- devaluation: decrease in purchasing power
- depreciation: decrease in currency
- so kapag bumaba ang exchange rate, tataas ang output. aggregate demand will sh
ift to the right
- MAGICALLY, (joke) pwedeng instant na output = natural rate of output kapag rig
ht size ang devaluation.
- sa simple aggregate demand relation, slow ang changes. kapag simple aggregate
supply relation, pwedeng direct kaagad ang effect
EXCHANGE RATE CRISIS UNDER FIXED EXCHANGE RATES
WHY DEVALUE OR CHANGE INTO FLEXIBLE?
1. Real exchange rate may be too high. Ibig sabihin, overvalued ang nominal exch
ange rate mo. Posible ito kapag ang ka-fixed exchange rate or ka-peg mo is masya

dong mababa yung inflation. Kapag masyadong tumataas ang exchange rate, nagkakar
oon ng real appreciation tapos pwedeng mag-worsen yung trade (kasi mas pinipili
ng tao ang foreign goods over domestic goods, thus more imports). Kaya mas nagpu
-push yung tao na mag-devalue.
2. Kapag gusto ng country na i-decrese yung domestic interest rate niya. Hindi n
iya kaya na mag-control ng interest rate kapag nasa fixed exchange rate siya, so
magttransfer siya into flexible para ma-control niya ang mga monetary policies.
- Kapag nagkaroon ng devaluation, magde-decrease ang pagho-hold ng domestic bond
s. What to do?
1. Government and central bank should convince markets na walang devaluation
2. Increase interest rate that will not lead into devaluation. Magkakaroon pa ri
n kasi ng capital outflow. Magbebenta ng domestic bonds, change domestic currenc
y to foreign, tapos bibili ng foreign goods. Magkakaroon ng depreciation.
3. High interest rates na bongga. People will not invest nor borrow. Ayun.
Devaluations can trigger exchange rate crisis. Kahit na wala namang intention an
g government na mag-devalue, kung masyadong assumera ang mga markets, mangyayari
siya. Lakas! =))

EXCHANGE RATE IN FLEXIBLE CHORVALOO

- lower exchange rate, lower interest rate
- in reality, nagmu-move ang exchange rate even though hindi naman nagmu-move an
g interest rate
- exchange rate = domestic interest rate/foreign interest rate x expected exchan
ge rate
- EXCHANGE RATES AND THE CURRENT ACCOUNT: basta any expected current accounts wi
ll definitely affect the exchange rate
- BASTA, REMEMBER THE FORMULA!!!
- Fixed Exchange Rate
1. mawawalan ka ng dalawang economic effects. Hindi ka makakabuo ng mga policy p
ara maka-recover sa mga shocks or exchange rate crisis
2. Kapag nagkaroon ng devaluation, people will ask for higher interest rates.
- Flexible Exchange Rate
1. Hard to predict the changes and thinking of monetary policy is not that simpl
e
WHAT SITUATIONS WILL MAKE YOU CHOOSE FIXED EXCHANGE RATE?
1. tightly integrated that magde-decide kayo na gumamit ng isang currency (EURO)
2. central bank cannot be trusted on monetary policies (dollarization/hard peg)
PAANO MAGIGING SUCCESSFUL ANG FIXED EXCHANGE RATE?
1. countries experience the same shocks
2. high factor mobility - pwede kang magpalipat lipat ng country