“The main argument against Mark 1 models of currency crises is not their assumption of an ‘asymmetry between super-smart speculators and super stupid governments’, but that they do not fit the facts.” Discuss. Many countries try to fix their exchange rate to a currency or a group of currencies by intervening in the foreign exchange markets. Fixed exchange rates can be fragile as they are vulnerable to speculative attacks and currency crises. For example, if investors fear the currency will soon be devalued, they will sell it, causing the currency to depreciate in value. However, governments still do so as they bring advantages.
Furthermore, the additional costs that are incurred to clean up and rebuild after a disaster takes away from government and private spending that could have been used towards economically advantageous ventures, rather than towards patching up a break in the value chain from damages in infrastructure. All in all, a natural disaster will almost surely hit an economy's currency hard. The Bottom Line These are just a few events that can have a profound effect on the currency markets. As you can see, the key points to take from this discussion is that much of a currency's value is derived from the economic strength of the nation, and any unforeseen uncertainty to predictable future forecasts of economic outputs will typically not work in a currency's favor. (Staff,2011) The rate of inflation in a country can have a major impact on the value of its currency and the rates of foreign exchange it has with the currencies of other nations.
Seigniorage, which involves the domestic government being able to tax the domestic currency, is definitely an argument on the fiscal side. If the need for more money in the form of bills and coins arise, the government can produce them as “no interest” coins and bills and are allowed to do with it what they see fit. Most, if not all, of these advantageous characteristics are threatened when a country decides to dollarize. It can be argued that dollarization is a legitimate option for developing nations for a couple for reasons. The first reason being, that the opinions in favor of a local currency are not as strong as they seem when faced with reality.
In a two country scenario, the domestic currency will depreciate when the foreign prices fall. In the event of domestic currency depreciation, the exchange rate appreciates and vice versa. Drawbacks: • The monetary model, although a useful establishment, can only be used to determine exchange rates in the long run due to its reli... ... middle of paper ... ...ately causing a significant change in the impact of such a monetary expansion • The model makes the unrealistic assumption that the economic environment is entirely static, this doesn’t account for the changes to the global economy as a reaction to the pound’s depreciation Economists have made several attempts to overcome some of these by extending the models; however, either due to lack of data or insufficient compatibility with predictions, their research has invariably fallen through. Research has been done to overcome the difficulty of prediction by incorporating nonlinearity of data, however even this only proves viable only over two to three years. This goes to prove that despite advancement in all other respects, the field of economics and international finance is still in need of a thorough means of exchange rate forecasting.
For example an artificial increase in the prices of sovereign bonds regulators require banks to hold. The sheer volume of new regulation means that banks have to focus enormous resources on regulatory implementation. There is a danger that with intrusive regulation the focus on regulatory compliance is actually acting as a distraction from proactively managing other business risks. There is also a danger that over regulation leads to decreased accountability if banks can point to following regulations. To operate banks need to be able to reasonably price and manage risk and generate adequate shareholder returns.
Finally this paper will look at the trend toward dollarization, and whether or not dollarization is the best solution for struggling economies. This paper contends that the power of globalization is forcing the international monetary community to address these issues. The success of the Euro makes a global currency seem like a logical step in the evolution of currency, even though sentimental attachment to national currency would make a global currency unpopular. Devaluation of national currency is only effective for nation with substantial foreign investment and high technology exports. Dollarization solves many problems for struggling economies in the short term, but at some point these nations should consider joining a Multi-Lateral Monetary Union.
High fluctuations of asset prices and exchange rates are a source of uncertainty for the real sector and cause misallocation. Hedging those risks is costly and in some cases not or only partly possible. Another crucial point against free financial markets is the loss of independence of economic policy. Under free convertibility of the currency and free capital markets, autonomous economic policy is only possible with free floating exchange rates but not with fixed ones. Therefore, if a country's objective is currency stability, it will have to give up the independence of its economic policy.
The banking industry, however, has proclaimed that it would promote mainly negative outcomes throughout the global economy due to higher required capital ‘set aside’. In light of this contentious dynamic, this essay strives to give a balanced overview of the issues at stake, and to critically analyse the arguments advanced in the article attached to this document. As a result, it highlights Basel III’s potential positive and negative effects when fully implemented, as well as several credit rating agencies’ shortcomings, which were mainly exposed due to the financial crisis. Finally, it concludes by arguing that the article lacks essential information, and the banking industry’s reactions signal an attempt by a powerful industry to maintain its exorbitant privileges. Although the article claims that Basel III will likely promote negative effects, such as an increase on the cost of credit to borrowers, it fails to acknowledge the potential benefits of that agreement.
More specifically, fiscal policy has a significant effect on inflation in countries where government securities markets are less developed. In this connection, Telatar, Telatar and Ratti (2003) argue that term structure contains important information about future inflation and therefore can be used as a guide for initiating monetary policy to target price stability. According to their study, short-term borrowing at high interest rate stimulates re-borrowing in order to repay the debt services, thereby creating a viscous circle of high budget deficits and high interest rates. Since political weakness is one of the major reasons to this chronic and high budget deficit and inflation, the development of stable political institutions is therefore necessary in order to stabilize prices.
I feel that while the financial markets are the main controller of the global economy, they require political involvement to regulate these markets, to attempt to prevent major crashes, and allow the markets to continue. Without political involvement, it can be seen that markets run ‘too’ freely, and allows for things like manias and large ‘bubbles’ to form, which in turn result in downturns in the market. Government establishments have also allowed for greater multinational and transnational trading, perhaps at the expense of smaller domestic market as said by Peter Mooslechner, Helene Schuberth and Beat Weber in their book ‘The Political Economy of Financial Market Regulation: The Dynamics of Inclusion and Exclusion, in which it is stated “the state has become far more a facilitator of global market processes than a protector of domestic market struc... ... middle of paper ... ...not as separate, coexisting or even opposed units, but as interrelated and integral to each other” . These regulating bodies set up trade laws that make foreign markets more attractive to potential investors, and this allows Trans and multinational trading to achieve larger economic stimulation, while at the same time aiming to curb the dramatic effects that market crashes have on the overall global economy, at the same time giving freedom to market actors to proceed with little bureaucracy, and freedom to trade in markets. A conceited effort for markets and government actors to agree of which forms of regulations are required, whilst still allowing a large degree of market freedom would be necessary in fixing the current global economy, with the 2 aspects of the economy working together, not as two separate entities, both with input in governing the global economy.