4.1

• Globalisation is the process of increasing interdependence between countries and the spread of culture, technology, and ideas
• What are some of the causes of globalisation

  • Containerisation
  • Political change
  • World trade organisation
  • Technology advancements
  • Multinational companies
• Evaluate the reasons for and against restrictions on free trade


  Protect from dumping

  Infant industry argument

  Protects domestic jobs

  Doesn't want to have a trade deficit

  However, distort comparative advantage, higher prices
• What are the components of the current account on the balance of payments?


  Trade in good balance: value of goods

  Trade in service balance: value of services

  Primary balance: income earned from assets owned abroad

  Secondary balance: payments received from foreign institution citizens
• What are the causes of imbalances on the current account?


  The value of currency, if currencies is overvalued, it creates unfavourable trading conditions for exporters, i.e. spiced, however, depends on the type of exchange rate

  Level of productivity if productivity is high, lower cost therefore lower prices which would make it more competitive abroad. However, even if productivity is seemingly strong competitiveness maybe undermined by a strong currency
• What are the remedies of a current account deficit? Talk about the economic cycle, exchange rate.


  A current account deficit caused by boom might self correct as the economy moved through its economic cycle. However, cyclical changes will not deal with a structural deficit that is based on a lack of competitiveness.

  In a free floating exchange rate depreciation may occur naturally, as demand for the currency falls. If a managed exchange rate, government may devalue currency. J curve.
• What are the remedies of a current account deficit? Talk about the protectionism, supply side policies.


  Import tariffs would increase price of imports, reduce domestic demand for them. However, other economies may retaliate. The country may have commitments such as EU.

  Policies to improve productivity and efficiency will help to reduce costs and make domestic producers more competitive. However, there could be a timelag and requires supply side improvements to be better than those of trading economies.
• What are the remedies of a current account deficit? Talk about demand policies.


  Contractionary fiscal, or monetary policy to reduce AD, unlikely in recession other macro objectives, likely to be higher priority.
• What is the J effect?

  Demand for import is likely to be inelastic in the short run so as a price of imports rises, the total value of imports rises. Overtime, as consumers respond to the price rise, demand shifts, away from imports.
• Who determines the floating exchange rate system?


  Free market forces, there is no government intervention. Example British pound
• What is fixed exchange rate system?


  One currency has a fixed value against another currency, most commonly countries fixed their currency against the US dollar or the euro.
• What is a managed exchange rate system?

  Free market forces of one determinant, but government may buy, and sell currency to influence its rates

  One type is the adjustable peg system. It is fixed in short term but can be allowed to adjust to changing economic climate

  Another type is the dirty float. It is a floating rate by intervention may be used to smooth out volatility,
• How do rates change?

  devaluation - an official reduction of the value of a currency under a fixed or managed exchange rate system

  Depreciation - of fall currency value due to free market forces

  Revaluation - and official increase in the value of currency under fixed or managed exchange rate

  Appreciation -arise in currency value due to free market
• What are the advantages of a fixed exchange rate system


  There is reduced volatility, however, firms can hedge against future changes by buying currency in advance.

  Financial discipline and government tempted to overspend. It removes the ability to control the current account balance through appreciation/depreciation. However, the flexibility of a floating rate means that current account imbalances can be resolved through it self correcting mechanism.
• What are the advantages of a floating exchange rate system?


  Robustus floating systems are more robust as they require. No government intervention. However, short term intervention in a managed system is relatively robust as there is no compulsion for government to intervene

  Economic cost of adjustment occur account deficit can be resolved through a floating rates. Self correcting mechanism. However, a depreciation is likely to create imported inflation which creates different cost for consumers.
• What are factors influencing floating exchange rate?

  Demand for exports, arise in demand for domestic exports means more foreign currency might be converted for domestic currency, leading to a rise in demand for domestic currency.

  Demand for imports

  Investment flows and increase in inward flows of investment funds would increase the demand for domestic currency

  Speculation, if speculators believer, currency will rise and values, they may de it, more, increasing its value
• Government intervention in a fixed exchange rate system


  1. Buying and setting currency

  2. Changing the interest rates

  3. Borrow large sums from institutions, like the international monetary fund

  4. Central bank can place limits on the amount of foreign currency that can be bought
• Governments do not have limitless gold and foreign currencies reserves
• Interest rates changes are far from certain to lead to decide outcomes as reactions can be unpredictable
• Borrowing large sums from institutions, like the international monetary fund, might be perceived as weakness by the currency markets
• High chance that a black market for foreign currency is created if central bank places limits on the amount of foreign currency that can be bought