Exchange Rate Practice Part 2

[@kurtreilly]

2) Buying large quantities of another currency to engineer a lower exchange rate is extremely risky. Not only is it dangerous to have such a large investment over which something you can't control, but it's likely to trigger retaliatory 'buying' up of currencies to counteract the effect. This would leave no country in any better position, only now possibly facing deflationary pressures (due to appreciating currencies.) Something which could very well shift AD leftwards!

[@kurtreilly]

1) Reducing interest would have the desired effect at first, although expansionary monetary policy could leave people with more disposable income as it becomes more attractive to take out loans/less attractive to save. In a country with a high MPI, higher income will likely mean more imports. More imports = more $ supplied on the foreign currency market which leads to an increased exchange rate for the dollar. Through the multiplier effect, the new ER could be even higher than before.

[@kurtreilly]

Dirty floating exchange rates are no good, even as something of a Keynesian, I accept that a free floating exchange rate is necessary. If used with meticulous supply side policies, it can be kept at an appropriate level.

[@kurtreilly]

3) Deliberate devaluation of the exchange rate does not work - just look at Britain in 1967. It's made on the assumption of perfect knowledge and that all economic agents are rational - but those assumptions are not correct. Businesses think their dollars are going to be worth less, so prices increase. Workers demand pay increases for the same reason - and inflation takes hold.