THEORETICAL APPROACHES TO DEVALUATION As stated by Cooper (1971), the discussions of the effects devaluation on economy’s output and balance of payments was explained by three approaches: elasticities approach, income/absorption approach and monetary approach. Elasticities Approach: - This approach emphasis on the substitution between goods, both in consumption and production, induced by the relative price changes brought by devaluation. According to Sugman (2005), the model was initially developed by Alfred Marshall and Abba-Lerner and later familiarized by Joan Robinson (1937). As described by Borena (2013), the model is based on some simplifying assumptions: i) it is a partial equilibrium analysis- it holds everything constant except …show more content…
Whiteman, K.Frekel and H.Johnson (Carbaugh, 1995). It explains what money market equilibrium implies for balance of payment equilibrium. The argument of this approach is that balance of payment disequilibrium involves inflow or outflow of money across nations and should be treated as monetary phenomena and calls for the application of tools and concepts of monetary theory. This approach can be explained in terms of fixed and flexible exchange rate regimes. Given a fixed exchange rate, the relationship between the demand and supply of nominal money is a crucial determinants trade balance. Disequilibrium in trade balance can be manifested through money market disequilibrium. This approach assumes that for any nation over a long run, the demand for money as a stock is stable and linearly depends on real income. That …show more content…
Therefore, change in foreign currency reserve (R) can restore or maintain money market equilibrium given that exchange rate is fixed. As cooper (1972) explained, these three approach are complementary rather than competitive and has its own weakness and strength. The elasticity approach is most suitable for small size market economies and if there is underutilization of full capacity. While the absorption approach takes this weakness in to account and focused on total output and income effect of devaluation. But it neglects the monetary effects of devaluation. EMPIRICAL LITERATURE There are different findings about the impact of devaluation on output and employment. Some empirical studies showed that devaluation is contractionary while others shows it is expansionary in some countries. Still some researchers showed the neutral impact and others found a mixed result. After Bretton Woods’s conference, international organizations like International Monetary Fund and World Bank suggested developing countries to adopt the Structural Adjustment Program in which countries are expected to liberalize their external sector. Some researchers like Narayam (2007) supported this idea in their study on
Economic indicators often affect and influence the value of a country's currency. The Trade Deficit, the Gross National Product (GNP), Industrial Production, the Unemployment Rate, and Business Inventories are examples of economic indicators. We will be dealing with four specific indicators: interest rate, inflation, unemployment, and employment growth, as well as Real Gross Domestic Product (GDP). Real GDP is so called because the effects of inflation and depreciation are accounted for in the figures. The state of the economy is important both on a micro and macroeconomic level.
Something that almost every person in America has in their wallet is money, whether it be 20 dollars or a one dollar bill. We all use money every day to eat, survive, and get around. The money supply in America can effect a single person to a large firm like the Apple Corporation. In this paper I am going to discuss the purpose money, how the government has the chance to influence the amount of money in our economy, and the monetary policy affects the Apple Corporation.
In the present day, the world's economy is ever-changing and adjusting. Many different reasons control the reasons for this. The future of currency is something that can only be predicted and is not guaranteed. However, there are many determing factors behind the changes that can take place. Asia and North America are two continents that have economies that have recently changed or are in the midst of change.
In the study of macroeconomics there are several sub factors that affect the economy either favorably or adversely. One dynamic of macroeconomics is monetary policy. Monetary policy consists of deliberate changes in the money supply to influence interest rates and thus the level of spending in the economy. “The goal of a monetary policy is to achieve and maintain price level stability, full employment and economic growth.” (McConnell & Brue, 2004).
This is a monetary policy which involves the government’s intervention to curb disorderly trends in the foreign currencies level. In case the quantity of a local currency goes down, the central bank uses the foreign currencies to buy its currency from the foreign economies. This ensures that the economy has ample home currency and thus enough money in circulation.
Elasticity is one of the most important theories in economics and it is a measure of responsiveness (Baker, 2006)i. There are mainly two types of elasticity, the elasticity of demand which includes price elasticity of demand, income elasticity of demand, and cross elasticity of demand as well as elasticity of supply (McConnell, Brue, & Flynn, 2009)ii. The degree to which a demand or supply curve reacts to a change in price is the curve's elasticity (Lingham, 2009)iii. Elasticity varies among products because some products may be more essential to the consumer.
...price and devaluation of the domestic currency to bring it back to A from A’ the country has to sell off its Foreign assets.
Money supply is the availability of money in the hands of the public (economy) that can be used to purchase goods, services and securities. In macroeconomics, the price of money is equivalent to the rate of interest. There's an inverse relationship between money supply and interest rates. As money supply increases, interest will decrease. On the other hand, interest will increases as money supply decreases. It is very important to understand that the economy works at market equilibrium. There are several factors affecting money supply; and these contributing factors will be the main focus of this paper. Understanding the basic principle on money supply is imperative to have a good grasp on the macroeconomic impact of money supply on business operations.
...mploys the VAR approach method of Lee (1992) to analyze the relation and dynamic interaction among variables. The IRF and the FEVD from the VAR model are computed in order to investigate interrelationships between money supply shocks and inflation the system.
The Classical system takes place in a closed economy which spontaneously moves toward full-employment equilibrium. The principle fueling such a system is that money wages are flexible, and the employment equilibrium is not affected by the “nominal” amount of money in this dichotomous system. However, there are limitations to the Classical model; mainly that it does not work in the short-run because it fails to account for market dynamism. The theory assumes automatic adjustment of markets from one equilibrium to the next and ignores periods of change, or disequilibrium.
This is an exchange rate system where the currency exchange rate system is allowed to be determined by the forces of demand and supply. Here, the central bank and the government do intervene to cub extreme exchange rate fluctuation by adopting monetary or fiscal policy.
The leading model, Monetary Model links exchange rate movements to the balance of payment, which is used for medium to long term analysis. The following assumptions cons...
It is here considered as currency (including coins), bank deposits, and traveler’s cheques. is the velocity of money. This reflects financial institutions and other economic conditions. is the deflator. It is a weighted average of prices of all final goods and services produced in the economy. It is, therefore, the broadest-based measure of the nation’s price level. is the total market value of final goods and services produced in the economy during one year of time. A rise in money supply, through its impact on aggregate demand, results in an increase in nominal . If velocity of money is held constant, an increase in nominal is proportional to the increase in money supply. In order to determine the impact of a rise in money supply on inflation/price rate, we rewrite equation (2.21) to obtain equation
There are many factors that affect the economy, inflation is one of them. Basically inflation is risingin priceof general goods and services above a period.As we see value of money is not valuable for the next years due to inflation. Today every country has facing inflationary condition in their economy.GDP deflator is a basictool that tells the price level of final goods and services domestically produced in an economy.GDP is stand for gross domestic product final value of goods and services, Furthermore GDP deflator shows that how much a change in the base year's GDP relies upon changes in the price level. . Inflation in contrast, how speedy the average prices intensity is increases or changes above the period so the inflation rate define the annual percentage rate changes in the level of price is as measure by GDP deflator more over GDP deflator has a advantage on consumer price index because it isn’t only based on a fixed basket of goods and services. It’s a most effective inflation tool to identify the changes in consumer consumption and newly produced goods and service are reflected by this deflator. Consumer price index (CPI) is also measure the adjusting the economic data it can also be eliminate the effects of inflation, through dividing a nominal quantity by price index to state the real quantity in term.
Money is an important instrument in any monetary economy in that it performs four specific functions, which can overcome the problems of barter trade (Anderton, 2000) . One of the function is medium of exchange. Money as a medium of exchange removes the inefficiency of the barter system. The introduction of the money as a medium of exchange in the economy eliminated the need for a double coincidence of wants because generally people could now accept money in exchange for goods and services (HARCOURT, 2013).