Ongoing discussion surrounds the role that exchange rate policies have in economic development and growth. When it comes to exchanging rate policy, the macroeconomic literature on developing countries focuses on two key and linked issues: exchange rates, the balance of payments, and macro stability.
Currency exchange system and capital inflows manager’s skills to control pro-cyclical volatility in external funds to emerging or developing economies, terms of trade fluctuations in commodity-exporting countries, and open or limit the area for counter-cyclical macroeconomic policies, thereby influencing macroeconomic stability,
Exchange rate policies are important in open economies for both of these reasons. What role can real exchange rate (RER) policies play in encouraging economic development? We explain how optimum RER policies are reliant on the circumstances under which they are executed, such as the available policy tools at that time. But we still refer to real exchange rate policies despite the fact that the real exchange rate (RER) is an influential factor and not a direct policy instrument. This is because real exchange rate policies are based on managing a set of actual policy instruments – which includes, of course, interventions associated with the nominal exchange rate.
Real Exchange Rate and Economic Development
There are several causes why a central bank will be worried about the exchange rate. 1) Changes in exchange rates will influence consumer spending in an economic system. 2) Common significant changes in exchange rates can destabilize foreign trade and lead to problems in a nation’s banking system.
The value of the euro in U.S. currency in 1999 was $1.06/euro when it was initially introduced as a currency. End-of-2013, the euro had climbed (and weakened) to $1.37/euro, while the dollar had fallen. As of late February 2017, it was back to $1.06 per euro. A French company that incurs annual expenditures of €10 million and sells its products in the United States for $10 million may be a good example of this type of situation, as well as for understanding bid and ask price in Forex, which are some of the main terms in FX trading. Because the exchange rate was $1.06/euro in 1999, the business got €9.4 million and incurred a loss. If you convert $10 million back to euros in 2013 at the exchange rate of $1.37/euro ($10 million [€1 euro/$1.37]), you get about €7.3 million and a far greater loss than in 2012. Beginning in 2017, at a $1.06 euro exchange rate, the company would once again incur a loss. Because manufacturing expenses in the home currency are higher than sales earnings in another nation, according to Axiory broker a stronger euro inhibits exports by a French company. The example also illustrates how a lower U.S. currency stimulates exports from the perspective of the U.S. economy. Although it is obvious from the fact that an increase in exports leads to more dollars coming into the economy whilst an increase in imports results in more dollars flowing out of the economy, it is important to remember that exchange rates also play a role. To some extent, it may be easy to claim that the American economy has lost out when someone in the United States purchases a Japanese automobile for $20,000 instead of paying $30,000 for an American car. As a result of this, the Japanese firm will have to convert the dollars into yen in order to pay its employees and run its factories. This saves the consumer money, which he may then use for other things.
Fluctuations and Exchange Rates
For a short period of time, exchange rates can vary wildly. Further, the Indian rupee fell from 39 to 51 to the dollar in March 2009, a drop of more than one-fourth in the foreign currency markets. Export-dependent firms, firms that depend on imported production inputs, and even firms with no international trade ties that compete with international firms – which in many countries accounts for half or more of a nation’s GDP – can see their profits and losses drastically shift as exchange rates fluctuate dramatically. As part of maintaining a stable business climate, a central bank may want to restrict exchange rates from fluctuating too much so that companies may focus on productivity and innovation instead of responding to exchange rate changes.
The banking system is one of the most economically damaging impacts of exchange rate changes. A few major currencies are used by financial organizations to measure most foreign loans. These currencies include US dollars, Euros, and Yen. Often, banks in countries that don’t utilize these currencies borrow money in foreign currencies, such as dollars, and then lend it back out in their own local currency.
What happens in this scenario? The dollar gains, which leads to lower baht. The currencies of nations in eastern Asia such as Thailand, Korea, Malaysia, and Indonesia depreciated sharply in the late 1990s and early 2000s, in some cases by up to 50%. Bank lending increased by 20 percent to 30 percent each year in many nations through the mid-1990s. Argentinian events in 2002 were quite similar to those in Venezuela. A depreciation of the Argentine peso rendered Argentina’s banking system insolvent.
To make transactions easier, and provide loans to businesses and individuals, banks are essential in any economy. This can lead to an abrupt drop in aggregate demand and a significant recession when all of a country’s biggest banks fail at once. Weighing in on whether substantial and unforeseen currency depreciation would push most current banks into bankruptcy is one of a country’s central bank’s most important duties, which include controlling the money supply and maintaining a stable banking sector.
Stable exchange rates enable international trade and decrease economic risk. If the nation wants to increase aggregate demand and decrease recession, it may desire a lesser exchange rate. If the nation wants to fight inflation, it may want a stronger exchange rate. If the country’s exchange rate moves rapidly between weak and strong, it risks crippling its export sectors, and if it moves rapidly from strong to weak, it risks crippling its banking industry. There are costs associated with every decision of an exchange rate, whether it be stronger or weaker, stable or fluctuating, to name just a couple.