Sample Economics Paper on Flexible Exchange Rate

Introduction

Under the open macroeconomic model, the exchange rates are deemed to fluctuate, and this greatly affects the economy. The volatility of the exchange rates is majorly affected when the exchange rates float. Increased volatility is expected to have a great effect on the exchange rate for both the commodity market shocks and the asset market (Weale et al., 2015). The volatility of the exchange rates is caused by the currency substitution, balance of trade and news as discussed below.

The balance of Trade. The balance of trade contributes to exchange rate volatility via its effects on the demand and supply of foreign exchange. When a nation’s trade account fails to have a net of zero; imports and exports are not equal, this leads to more demand or supply of a country’s currency. Consequently, this influence the global prices of that currency.

Currency substitution and Fluctuations. The extent to which the exchange rates are volatile can be connected with the degree of undershooting and overshooting of currency substitution. Also, foreign currency exchange rate and borrowing pose economic implications on the balance of trade, as well as the asset market. In some instances, the balance of trade can be a misleading indicator of the exchange rate, but when the balance of trade is negative, it tends to affect the exchange rates of local currency negatively (Edwards, 2015). When the exchange rate depreciates, currency reinterpretation of the balance of trade is required, so that the exchange rates are adjusted back to have balanced trade. The currency fluctuations are caused by the model of valuation options such as the call and put options. Such fluctuations and deviations are reported by the call prices, thus affecting the exchange rates.

News. The news lead to exchange rate volatility because markets respond quickly to unexpected news and investor may overestimate the possible volatility and damage, this can lead to currency substitution and more demand for currencies of countries with a stable economy. Further, the news might affect the global macroeconomic and financial statistics. The financial news primarily provides information related to the statistical reports which evolve through the monetary actions of the federal, the macroeconomic releases by the government and the geopolitical events in an economy (Ghosh et al., 2015). Therefore, such indicators on the news will greatly affect the exchange rate, since they evolve within the financial market.

 

References

Edwards, S. (2015). Monetary policy independence under flexible exchange rates: an illusion? The World Economy38(5), 773-787.

Ghosh, A. R., Ostry, J. D., & Qureshi, M. S. (2015). Exchange rate management and crisis susceptibility: A reassessment. IMF Economic Review63(1), 238-276.

Weale, M., Blake, A., Christodoulakis, N., Meade, J. E., & Vines, D. (2015). Macroeconomic policy: inflation, wealth and the exchange rate. Routledge.