Globalization on Developing Countries
Globalization is described as the process that aims at expansion of business operations at an international level and it is precipitated by global communications as a result of technological advancements as well as political, economic and socioeconomic developments. In developing countries, globalization has brought with it numerous new opportunities. Developing countries can now enjoy greater access to technology and markets thus improving productivity as well as the standard of living of the local people. While this is the case, it has also impacted developing countries in a negative manner.
The degree to which developing countries benefit from globalization varies greatly. This is because there are skeptics who argue about the benefits accrued from globalization hence resistance to globalization. One major way through which developing countries have benefited is through trade. This is principally achieved through imports especially when Asian economies performance is taken into consideration. Trade has broadened markets for producers in developing countries making it easy for them to real from the scale of economies. What is more, globalization has forced local producers to become competitive while at the same time offering the opportunity to develop some new technologies.
Other major effects of globalization on developing countries are as highlighted below:
- Improved living standards-Globalization at economic levels has given governments the opportunity to acquire foreign lending. Once the funds are acquired, they are used in improvement of infrastructure such as health care, social services and roads. What is more, it has also improve the general living standards of those living in developing countries.
- New markets access-Thanks to globalization, countries are now able to carry out free trade and this has proven to be one of the major benefits to developing countries. Homegrown industries for instance have witnessed a fall in trade barrier opening access to a wide international market. The growth generated from this makes it possible for companies to come up with new technologies and also produce new services and products.
- Widens income disparity-Though there is an influx of foreign capital and companies, globalization also leads to increased cases of unemployment as well as poverty. What is more, it also increases wage gap between educated individuals and those who aren’t educated. In the long term though, the level of education rises because the financial status of the country develops as well. however, in the short term, the poor people become even poorer and not everyone participates in improvement of the economy.
- Decreased employment opportunities-While there is an influx of companies in developing countries, there is also a decrease in employment opportunities especially in sectors for workers who are skilled. This is attributed to technology improvement which comes with the newly established businesses. Automation for instance in agricultural and manufacturing sectors eliminates the need for skilled laborers.
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People from different parts of the world have become more connected now than they were before. Now, it is easier for money and information to flow easily. Services and products produced in one part of the globe are becoming available in almost all parts of the globe. All this is because of globalization which has become a major tidal wave that cannot be stopped. The concept of globalization has some clear disadvantages and advantages.
- Employment opportunities-This is considered the major benefit of globalization. Companies are setting up shop in new countries creating opportunities for employment. What is more, people are able to migrate easily further creating opportunities for better jobs.
- Education-With educational institutions spread across the globe, it has become easier to move from home countries for better education opportunities. This has led to integration of cultures and people from different educational backgrounds. Countries that are labor intensive as well as developing nations have accrued the most benefits from this.
- Thanks to international trade, trade has become more competitive leading to production of high quality products. Products now have to be enhanced so they can capture the attention of consumers. Consumers today can make compromises when it comes to price but not quality.
- Price of commodities has also become cheaper especially because of the fierce competition noted in the market. There are different products for consumers to choose from making it a necessity for producers to price them competitively.
- Socially, people have become more tolerant and open towards one another. Additionally, globalization has also enhanced communication
Globalization is not all rosy. It also has some disadvantages pegged to it and these include the following:
- The most common complaint is that globalization has only served to make the rich even richer while making the poor poorer. It is the general feeling that for managers, it is a great benefit while for nature and workers, globalization is hell.
- Multinationals have been accused of unfair working conditions and social injustice. They have also been accused of not caring so much for the environment, ecological damage as well as natural resource mismanagement.
- Anti-globalists claim it has not worked in favor for a large section of the population. During 1968 through to 1998, they claim inequality has only gotten worse. The United Nations Development Program for instance reports 20% of the world’s rich population used 86% of the global resources while 80% of the poorest population only gets 14% of the global resources.
- Globalization has also led to incursion of diseases especially deadly ones like HIV/AIDS spread by travelers in some cases, to the most remote regions in the world.
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Demand and Supply of Real Estate
Real estate is an area that covers broad issues. It is any property consisting of land and the different buildings on it and with the exceptional natural resources available. The number of people investing on the buying, selling, building and renting land has been increasing tremendously due to increased demand. Real estate has always represented a part of many peoples prosperity. The real estate market is quite competitive and volatile, but there are a number of factors affecting demand and supply of the real estate market to think through always.
There is a vast history on the real estate market. Nearly one-third of America is into real estate investments. The size and measure of the real estate market has made the industry attractive and money-spinning for thousands of investors. Demand and supply are a few elements of the business sector that have impacted the business sector greatly. Fundamentally, there are numerous factors that affect demand and supply of real estate and they include;
Any changes in interest rates influence a person’s ability to purchase any residential property. Essentially, as interest rates decline, the cost to obtain a good house decreases and this pushes the demand for real estate higher regardless of the location or size of the houses or related property. On the other hand, if the interest rates increase, the cost to purchase a rental house will increase lowering demand and prices of the entire property.
Demand for rent estate relies upon income. With the ever growing economy and rising peoples’ income, many investors will spend huge amounts on houses and this will push prices up and increase demand. Rental houses for many years have been seen as luxury goods and rise in income has increased the number of people in need of houses. Rising income leads to bigger percentage of money spend on houses.
These are factors that describe the composition of a population such as income, migration, population growth and gender. Demographic shift can easily impact real estate market. With smaller income, it is not easy to acquire those huge and costly houses.
In the flourishing of years of 1996 to 2006, many banks and other money lenders were keen in providing mortgages to clients in need. Many people borrowed large amounts at lower deposits and this increased demand for real estates as more people were willing to buy. However, the disastrous recession and increased inflation years impacted the sector negatively and less real estate investments were made.
Confidence is a great trait to consider while taking risk to take out mortgage for real estate in the market. If people fear getting mortgages due to likely to decline prices of houses, many will defer while placing their orders.
The ratio of rental houses prices to income impacts their demand. Houses prices rise relatively to income. Hence, a few people will be able to invest in the real estate sector and fulfil their dreams. The size and quality of real estate market or sector make it attractive for many invests, however, it is wise to research and consult extensively in order to go for what satisfies your needs.
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Factors Affecting Demand and Supply of Labor
Demand and supply are substantial elements of economics. In fact, they are the backbone of the regional, national or global market. Without labor, it is not that easy to develop the economy has there will be no income or revenue that aids boost any nation’s economy. There is a great relationship between demand and supply of labor. Companies should always determine how much of each input even before making output or any pricing decision. To enjoy the labor market, it is great to also consider factors affecting demand and supply of labor.
The relation between demand and supply brings about the forces behind the allocation of resources. The demand and supply of labor is generally determined by the labor market and the mainstay participants are workers and companies. Workers are significant to any firm as they offer labor whereas firms guarantee wages. To make good profits, companies should invariably optimize the factors of production and labor.
Every company demands labor and hiring more workers guarantees productivity. Most of the markets in the world are competitive and also demands workers with the highest degree of mobility. All in all, there are a number of factors that are known to affect demand and supply of labor and they include;
- Economy- Loss of jobs during hard economic times mean less disposable income to much labor for involved companies. Majority of the firms experience less production and there is reduced supply of labor. Supply of labor will easily increase with an increase in wages. Hence, there will be more workers willing to work in a company of the pay is exceptionally good. Demand for labor will increase with a rapidly growing economy. On top of this, an increase in population will lead to an increase in supply of labor.
- Globalization- Many multinational companies have established new companies or branches in not only developing nations, but also in developed countries. This move has impacted the demand and supply for labor greatly. Many companies have invested in developing countries due to the high availability of labor in the nations. In addition, the demand and supply for labor has been high as majority of the citizens in these countries are in search for jobs and good pays.
- Better compensation- Compensation in any marketplace includes benefits and wages. In many countries, there has been an upward pressure on wages and descending pressure on benefits. Lowering working age has many times increased the supply of labor. Many governments have increased the retirement age and this has ascended the increase in the supply of labor hence increased productivity.
- Factors such as educational requirement, social factors, new technologies and unforeseen events have all impacted demand and supply for labor in one way or another.
Many times, individual’s supply of labor depends on his or her partialities. By working extra hard, an individual supplies more labor, but reduces his or her consumption of leisure time and increase productivity. With different markets that exist in the world, it is wise to be well-versed with all factors that affect demand and supply of labor.
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Expansionary Monetary Policy
Expansionary monetary policy is described as a policy that increases the supply of money in a country for purposes of encouraging economic growth or fighting inflation. A good example of this kind of policy is the fiscal policy which takes the structure of rebates, increase in regime spending and tax cuts.
Also, such policies originate from central banks known to focus on the increase of money supply within an economy. The policy injects capital into an economy directly and also manages low periods of growth in business cycles. Whenever the Federal Reserve of the US reduces its rate of federal discount rate or funds, it uses this policy. Additionally, it also uses the policy whenever it buys treasury bonds in an open market. Consequently, capital is injected directly.
There are several advantages associated with expansionary monetary policy. It is implemented for purposes of stimulating the economy whenever a cycle of business contraction is expected. It also addresses unemployment problems within the system. Some of the advantages associated with the policy are as highlighted below:
- It leads to bond prices increase and interest rates reduction
- It decreases exchange rates leading to increased exports as well as decreased imports and consequently leading to balance of trade.
- Domestic bonds are made unattractive by the low interest rates and this decreases their demand while raising the demand for foreign bonds.
- Low interest rates leads to a high capital investment level.
During recession, an expansionary monetary policy is known to spur economic growth. By injecting money into the economic system, the interest rates are lowered easing restrictions on credit that banks apply to application of loans. As such, consumers as well as businesses are able to borrow money easily and at the same time spend more.
As consumers spend more, businesses also benefit by enjoying increased profits and revenues. This makes it possible for companies to update equipment and plant updates, as well as hire some new employees. When this policy is applied, the rate of unemployment goes down as well since companies can borrow money easily to expand operations.
This policy can also lead to inflation in cases where the economy is robust therefore creating surplus money. Majority of people wrongly believe inflation is the result of high prices while in fact, it arises where there is much money chasing the available services and goods thereby making money lose value in relation to products purchased. As a result, the price rises because consumers are competing for the products available which are offered to those who state the highest prices.
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Expansionary Monetary Policy Vs Contractionary Monetary Policy
A monetary policy can either be contractionary or expansionary. The former accelerates economic growth while the latter restricts it. Conventionally, an expansionary policy is used to address issues of joblessness during depression by lowering the rate of interest with the hope easy credit will attract companies to expand. This is achieved by increasing money supply in an economy.
These policies are often used in accordance to the state of the economy at any given time and they both have some pros and cons. The contractionary policy is used to promote stable prices and reduce inflation. The process used to do this involves complex steps undertaken by the central bank which includes estimating the existing economic conditions and predicting what course the economy will take in the following years (preferably 2 years).
Once this is done, the central bank has to compare the results with its inflationary and economic growth goals. If the estimated inflation is more than the central banks goals, contractionary measures are employed. Some of the actions taken might include high short term interest rates and high reserve requirements which reduce the supply of money and slow down the pace at which an economy grows. The major disadvantage of this is the fact that companies and consumers find it difficult to get loans and what is more, it leads to increased cases of unemployment.
An expansionary monetary policy is the exact opposite and its effects are also different. The purpose of this policy is to expand the supply of money and at the same time, increase economic activity. This is achieved by keeping the interest rate low through addition of money into the system via open market. This is also carried out by the central bank and the goals of an expansionary monetary policy includes spurring economic growth, increasing employment opportunities and ensuring there is price stability.
A contractionary monetary policy has the exact opposite effects. Central banks have to be open and thorough when making a decision on which of these two policies to implement as they can have adverse effects on the economy. For instance, an expansionary policy has lagging effects which are noted between the time the policy is implemented and when the effects are felt. As such, it causes high cases of unemployment because businesses cannot expand.
Decisions on monetary policy take a long duration for them to be effect on the economy and especially in cases of a complex and large economy like that of the US. Therefore whether it is expansionary or contractionary policy, the effect exerted is not an immediate one.
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Effects of an Expansionary Monetary Policy
The role of an expansionary monetary policy is that of increasing economic growth and commonly lessening unemployment and the increase in prices. The policy can be implemented in varying ways some of which are as highlighted below.
- The central bank can implement this policy by buying government bonds in an open market.
- The policy can also be enacted by increasing discount window lending amount
- Finally, it can be enacted by decreasing reserve requirement
The effects of this policy are varied and while this is the case the most common ones include the following:
The money injected into an economy when conducting market operations is used by consumers or alternatively used by businesses for purposes of hiring new workers or creating growth. This policy comes with low interest rates which make it affordable for consumers to purchase houses, cars and other items. What is more, it also leads to expansion of businesses. Low reserve requirements also make it possible for banks to issue more loans and this increases credit supply and lowers interest rates charged by banks.
This policy has the tendency to increase the prices of real estate and stock as well. Apart from increasing stocks demand through creation of additional money, reduction of bond prices accompanying this policy increases the attractiveness of bonds. Because of the low interest rates, consumers find it easier to buy new houses increasing real estate value. Most households have their wealth either in stocks or real estate which means an increase in the value of these two creates more wealth for households.
Whenever the interest rate in one country falls compared to that of other countries, the country with the best monetary policy experienced a fall in currency. When a nation’s currency decreases its value, exports become cheaper while the imports price increases consequently, boosting the economy of that nation further.
Though this policy is great for an economy that is depressed, it can also cause inflation or rise in prices especially in an economy that is close or at full capacity. This is attributed to the fact the increased money outstrips productivity capacity of that economy. This happens because often, there is a lag during the process of implementing the policy hence the impact is not felt immediately. Therefore, the Central Bank is supposed to judge accurately, not the current performance of the economy but rather, how it will be at some point in the future.
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Contractionary Monetary Policy
Contractionary monetary policy is defined as macroeconomic tool that is used by the central bank of a country or its finance ministry for purposes of slowing down the economy. This kind of policy is enacted by a government with the aim of reducing the supply of money and ultimately, spending within a country. There are a couple of ways through which this is done and they include the following:
- Increased interest rates
- Increased reserve requirements
- Reduced money supply either indirectly or directly
The policy is used during growth periods of business cycle that are high but he effect is not immediate. Therefore, this means the purpose of the policy is emphasizing on reduction of money supply for less investment and spending thereafter slowing the economy down. The idea is making sure people spend less by making the prospect cost of holding cash high. The policy’s effectiveness varied in accordance to investment and spending patterns in the economy.
The major purpose of this policy is slowing down inflation which accompanies a flourishing economy. The government will apply different techniques to accomplish this and they include, slowing government spending. The interest rates can also be raised making it more costly to borrow money. Inflation is slowed by reigning economic growth and this aids cool the markets off and also decreases overall demand which means the prices also go down.
Inflation leads to ever rising prices and this eventually negatively impact the spending power of the consumer. The fluctuation of prices can leave the consumers erratic and nervous in regard to spending patterns. This policy aids stabilize prices as inflation slows increasing consumer confidence and keeping the economy even while encouraging spending patterns that are stable.
A contractionary monetary policy slows down production. This is a by-product of the country’s economic engine slowing down. The major culprits in this case include r3educed product and service demand as well as costly investment capital. Once production is geared down by companies, it often takes years before it is ramped again. If this policy exceeds the mark and tightens a country’s economy relentlessly than intended, companies slow down production and this in turn shutters plans for expansions. Consequently, this throws the economy into a recession loop.
Contractionary monetary policy can also cause increased rate of unemployment because as companies slow down their growth rate, they are forced to hire less employees. Increased cases of unemployment cost the government increased insurance admin costs as well as social service expenses. Therefore, governments are supposed to weigh the cost of this against economic benefits associated with inflation reduction. High rates of unemployment can reduce consumer confidence as well.
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Objectives of the World Trade Organization
The World Trade Organization was formed after GATT members signed an agreement in 1994. Unlike GATT, the World Trade Organization was formed after signing an international treaty that was approved by all participating countries. Thus, organization has an international status just like the World Bank and the IMF. However, the WTO is not a United Nations’ agency.
GATT was not an organization but a legal arrangement but the WTO is an international organization established as a permanent institution. It acts as the watchdog in the world of goods, services, foreign investment and intellectual property trade among others.
The main objectives of the World Trade Organization are as follows:
- To implement a new system of the world trade as envisioned by the treaty
- To promote global trade in a way that is beneficial to all member countries
- To enable developing countries to secure a balance in sharing the advantages of the expanded international trade that corresponds to their growth and developmental needs.
- To eliminate hurdles that hinder the establishment of an open global trading system while ushering in an international renaissance economically since global trade is a crucial instrument that can boost economic growth of the member countries
- To boost competitiveness among the trading partners in order to benefit consumers while fostering global integration.
- To increase productivity and production levels with an aim of boosting employment levels globally.
- To utilize and expand global resources to maximum levels
- To improve the living standards of the global population while boosting economic development in the member countries.
- To eliminate discriminative treatments in terms of the international trade
- To boost real income as well as trade in services and goods in the member nations.
- To enhance environmental protection while accepting concepts aimed at enhancing sustainable development in member nations.
Since its establishment, the World Trade Organization has provided a forum via which member countries negotiate their relations in multilateral trades on the basis of the treaty that was signed in 1994.
The organization has also administered the procedures and rules that govern the settlement of different trade disputes. It also administers the review mechanism of trade policy. The World Trade Organization cooperates with the International Monetary Fund when appropriate to enhance coherence in the process of making global economic policies. It also cooperates with the World Bank and other affiliated agencies in enhancing coherence in the global economic policies.
Additionally, the World Trade Organization has facilitated the implementation, operation and administration as well as furthering the objectives of the agreement signed in 1994 and multilateral trade treaties while providing a framework for the administration, operation and implementation of plurilateral trade treaties.
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Objectives of the World Bank
The World Bank also called the International Bank for Reconstruction and Development is a global financial institution that offers financial assistance to member countries while supplementing and promoting private foreign investment as well as promoting a long-range balance in the growth of the international trade. It was established in 1945 and opened officially in 1946.
The World Bank played a significant role in the reconstruction of countries that had been destroyed by the Second World War. Since the 1960s, the focus of the World Bank has shifted from the industrialized countries to the development of the third-world countries. It has done this by providing long-term investment loans with reasonable terms to these countries and private investors.
Among the objectives of the World Bank include the following:
- To help in the development and reconstruction of the territories of its member countries by facilitating capital investment through productive means such as economic restoration of countries disrupted or destroyed by war. It also does this through reconversion of the productive facilities for peaceful needs and encouraging establishment of productive resources and facilities in the developing countries.
- To promote investors through participation or guarantee in loans as well as other investments that private investors make.
- Supplementing private investments through provision of sustainable finance conditions when there is no sufficient private capital on reasonable terms for productive purposes. It does this by providing its own capital fund.
- To promote a long range balanced development and growth of the international trade as well as maintaining equilibrium in the balance of payments. It does this by encouraging international investors to develop productive resources in member countries, thereby helping in enhancing productivity, living standards, and labor standards within their territories.
- To arrange for loans made and/or guaranteed in regards to the international loans via other channels to ensure that more urgent and useful projects, small and large alike are handled first.
- To execute its operations while considering the effects that international investment has on the business conditions of the member countries and also the immediate post-war period. The World Bank also aims at ensuring a smooth transition from the war period to the peacetime duration and fostering economic prosperity of the world.
In trying to accomplish these objectives, the World Bank provides technical support to its member countries. For this reason, it has formed The Economic Development Institute. Member countries can also get loans from this bank of up to 20 percent of the share of the paid-up capital. The World Bank determines the conditions, terms and interest rates of the loans that it gives its member countries.
Generally, the World Bank gives loans to members for specific and dully submitted projects. The debtor country repays the loan in the currency via which it borrowed it or reserve currencies. Before borrowing loans from the World Bank, private investors are required to seek permission from the countries where they will collect the money.
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Floating Exchange Rate
Floating exchange rate is also known as fluctuating exchange rate and it refers to a kind of exchange rate system through which the currency value is given time to fluctuate in accordance to the market foreign exchange. A currency using floating currency is commonly referred to floating currency and it is contrasted with a currency that is fixed.
It is the decision made by a country to allow the value of its currency to change in a free manner. In such cases the Central Bank does not constrain the currency and it is not required to maintain relationship with other currencies. The value of the currency is determined by trade in foreign exchange market.
Most of the currencies in the world can be described as floating and they include some of the most traded currencies such as the Dollar, the Japanese Yen, the Euro, British pound as well as the Australian dollar. Initially, the Swiss franc was traded through a floating exchange rate but from 2011 September it was pegged to euro. Central Banks are often known to participate in markets for purposes of attempting to influencing floating exchange rate.
Canadian dollar in more than one way is similar to a “pure” floating currency as the Central Bank hasn’t interfered with the price of the dollar since 1998. The United States dollar comes in secondly and it has little changes in the foreign reserves. This is contrast to the United Kingdom and Japan currencies which need intervention to a great extent.
From 1946 to the start of the 70s, Bretton Woods system ensure fixed currencies were the norm and in 1971 United States made the decision to no longer uphold the exchange rate of the dollar at 1/35th an ounce of gold such that the country’s currency wasn’t fixed anymore. After the Smithsonian Agreement in 1973, most of the currencies across the globe made the decision to follow suit. However, other countries like most of the States in the Gulf fixed their countries currency to the value of other currencies and this has recently been linked to slow growth rates in those countries.
Whenever a currency floats targets different from the exchange rate is used for purposes of administering monetary policy. Some economists think in most cases, a floating exchange rate is far preferable to one that is fixed. Floating exchange rate adjusts automatically enabling countries to reduce impact of foreign business cycle, shocks as well as preempt the chances of a crisis of balance of payments. However, in certain cases, fixed exchange rates are preferable because they offer greater certainty and stability.
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Fixed Exchange Rate
Fixed exchange rate is at timed known as pegged exchange rate and it’s a kind of regime where the value of the currency is fixed against the currency of another country to another value measure like gold. This kind of currency is used for purposes of stabilizing the value of one currency against the one it is pegged to. This in turn makes investments and trade easier and predictable between two currencies. This is especially of great use to smaller economies whose external trade contributed to the gross domestic product.
What is more, it is also used as the most suitable means for controlling inflation. While this is the case, while the reference value increases and goes down, the currency that is pegged to it is also affected. Fixed exchange rate was common during the twentieth century. Governments favored such systems because they believed it came with key advantages such as lowering speculative capital flow risks, introducing great discipline on local policies to get rid of inflation and removing exchange risk while promoting international trade.
Other benefits associated with fixed exchange rate are as highlighted below:
- Speculative capital flow-In a system with a fixed exchange rate, high inflation within a country makes buyers who are overseas pay high prices for the exports of that country. It additionally makes the import sector of that country less competitive. This means that as the imports are strengthened, the exports are weakened.
- No risk associated with exchange rate-Fixed exchange rate gets rid of the risk associated with changes in exchange rate. It was assumed absence of such risk would be beneficial to capital flow and international trade.
- Lack of automatic adjustment to payment of disequilibrium balance-This kind of rate doesn’t automatically correct balance of payment. The government is forced to make corrections in such cases by increase the interest rate and reducing domestic demand. Consequently, this restrains the economic policies at a domestic level from focus on inflation and unemployment.
Other advantages associated with fixed exchange rate include inherent instability and the prerequisite for foreign exchange reserves that are large. In a system where the fixed exchange rate is used, the government of the given country makes the decision regarding its currency’s worth in relation to either the fixed amount of another country’s currency, fixed gold weight. Typically, the market mechanism used is an open one in which case the central bank of that country makes provision of foreign currency that is required for payment imbalance financing.
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Factors Affecting Foreign Exchange Rate
Foreign exchange rate is always dynamic and it affects every sector of life. The economic health of a country is influenced by its current exchange rate. Consequently, it is important to understand some of the factors that affect foreign exchange rate.
When the interest rate of a country rises high or falls low than the rate of another country the currency of the country with low rate is sold while that of the country with a higher rate is bought for purposes of achieving high returns. Given the demand of the currency with a high rate, its value will increase against that of other currencies. The world today had become globalized and as such, the market trend has shifted towards one of free capital mobility and foreign exchange restriction elimination.
Differential in inflation
As a rule, a country that has a consistent low inflation rate will exhibit an increasing currency value since its purchasing power will rise relatively to that of other countries. Towards the end of the twentieth century, some of the countries that had low inflation were Switzerland, Germany and Japan while in countries like United States and Canada, it came later. Countries that have a high inflation witness depreciation in currency compared to the currency of trading partners. Usually, this will be accompanied by high interest rates.
Expectations of economic growth
In order to meet the need of an ever growing population, the economy must expand. However, in cases where the growth occurs at a very high rate, wage advances are outpaced by price increased such that the buyer power of consumers decreases despite the fact they earn averagely. Majority of countries target a 2% economic growth per year. With high growth comes high inflation and consequently, the central banks raise their interest rates in order to increase the borrowing cost and slow down spending in an economy. Changes in interest rates can signal currency rate changes.
Actions of Central Bank
With majority of major economies having an already low interest rate, government officials and the Central Bank have resorted to others measures which are not used often to intervene in the markets and influence the rate of economic growth. For instance, quantitative easing is used to increase the supply of money within an economy and this involves purchasing of government bonds as well as other assets from financial institutions to give them additional liquidity
Other factors that also affect foreign exchange rate include employment outlook, political stability, public debts, and terms of trade as well as economic performance.
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Equilibrium Exchange Rate
Equilibrium exchange rate refers the rate where currency supply meets demand of that same currency. Since foreign exchange rate is affected by several factors, equilibrium exchange rate is also influenced by factors of demand and supply. Therefore, equilibrium is achieved when the demand of a currency is equal to supply. Consequently, this rate equals to the PPP (purchasing power parity) of the currency where all markets are efficient and goods are traded.
This means that across all countries, the price levels need to be observed. The equilibrium rate is talked about as something that is different from what the current market rate is and this often means 2 things. One is that the real equilibrium exchange rate will at some point in the future be different from the rate observed today. Two, the policy towards nominal exchange rate facilitates in some way, adjustment towards the real future exchange rate. As such, the question on whether there is any sense in calculating equilibrium exchange rate on the basis of policy brings about two sub-questions which include whether there are analyzable and predictable real exchange rate shifts and if such shifts can be facilitated by the policy on nominal exchange rate.
There are a couple of factors that affect the shift in equilibrium exchange rate as they include:
The agreement that real events have the ability to change equilibrium exchange rate is a universal one. The only source of dispute is how frequent such shocks are as well as how large. One possible shift source in equilibrium exchange rate is secular trends presence which is as a result of technological changes and product mix differences among others. Another likely source that affects equilibrium rate is commodity price shock. For G-5 countries that are exporters, such shocks don’t have a large impact as is the case with primary exporters.
This is another controversial cause for shifts in equilibrium rate especially in capital flows noted international. Take for example a country that is a temporary recipient of capital flows. This could be as a result of an investment boom which is generated by resource discoveries or technological change attributed to tax law changes or bulge in deficits. Regardless of the source, capital inflows will be spent at a domestic level and this will raise the demand for nontrade goods that are domestically produced and in some cases, it can also raise the price of a country’s goods in the world markets.
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Pros and Cons of a Pegged Exchange Rate
A pegged exchange rate, also known as fixed exchange rate refers to an exchange rate whereby the central bank or the government pins its official exchange rate to the currency of another country (s). Sometimes, the official currency exchange rate can also be tied to the price of gold. The purpose for undertaking such a measure is to enable the country to maintain the value of its currency within a narrowly inclined band.
There are several benefits that a country can achieve with a pegged exchange rate. Likewise, there are also demerits to taking such a step. One of the arguments in favor of a pegged exchange rate is that it ensures a reduced risk when it comes to global trade. When a particular country maintains a fixed exchange rate, buyers and sellers are able to easily come to an agreement on the price to be applied for commodities. After the contracts are sealed, there will be no risks resulting from changes in exchange rates, thus, enhancing investment.
A pegged exchange rate is also an ideal avenue to be pursued towards instilling discipline in the management of economies. A fixed exchange rate gives governments the authority of not following inflationary policies. As a result of this, there will be reduced risks when it comes to problems arising from balance of payments and unemployment. Thus, the economy will become competitive. A pegged exchange rate is an ideal incentive that can enable governments to keep inflation on the low.
On the other side of the coin, a pegged exchange rate creates an environment where there is dire need for large foreign exchange reserves. A government that has implemented the policy of a fixed exchange rate requires huge foreign currency reserves at its disposal in order to maintain that rate. The lower side of this is that such kinds of reserves come with opportunity costs that can be quite expensive to a country.
Another con of a pegged exchange rate is that it is not flexible and creates a condition for limitations. With a fixed exchange rate, it becomes challenging to make response to temporary shocks. This is because there is always no chance for devaluation when the exchange rate is fixed.
A pegged exchange rate can also lead to imbalances in current account. This is because with an exchange rate that is overvalued, there are higher chances for deficits in the current account. Another demerit of an exchange rate that is fixed is that it is usually not easy to determine the right time for a country to join. If a country implements the policy of a pegged exchange rate at a high, its exports will not be competitive. On the other hand, inflation can be experienced when the rate is too low.
Owing to the pros and cons of a fixed exchange rate that are outlined above, it is clear why most economies prefer to implement it. A fixed exchange rate comes with numerous comparative advantages for trade that can help a country in shielding its economic interests.