The Price Adjustment Mechanism with Flexible and Fixed Exchange Rates Lecture 5 The Price Adjustment Mechanism with Flexible and Fixed Exchange Rates

Chapter 16 The Price Adjustment Mechanism with Flexible and Fixed Exchange Rates 16.1 Introduction 16.2 Adjustment with Flexible Exchange Rates 16.3 Effect of Exchange Rate Changes on Domestic Prices and the Terms of Trade 16.4 Stability of Foreign Exchange Markets 16.5 Elasticities in the Real World 16.6 Adjustment Under the Gold Standard

16.1 Introduction To examine how a nation’s current account is affected by price changes Assumption: No autonomous financial flows Exchange rate changes are utilized to correct a current account deficit

16.2 Adjustment with Flexible Exchange Rates The degree of depreciation needed to correct current account deficit depends on the elasticity of the demand and supply curve for foreign exchange

FIGURE 16-1 Balance-of-Payments Adjustments with Exchange Rate Changes.

FIGURE 16-2 Derivation of the U. S FIGURE 16-2 Derivation of the U.S. Demand andSupply Curves for Foreign Exchange.

16.3 Effect of Exchange Rate Changes on Domestic Prices and the Terms of Trade A devaluation or depreciation of a nation’s currency increases the domestic currency prices of the nation’s exports and import substitutes and is inflationary. The terms of trade of the nation can rise, fall, or remain unchanged, depending on whether the price of expots rises by more than, less than, or the same percentages as the price of imports.

16.4 Stability of Foreign Exchange Markets FIGURE 16-3 Stable and Unstable Foreign Exchange Markets.

16.5 Elasticities in the Real World FIGURE 16-5 The J-Curve.

FIGURE 16-6 Effective Exchange Rate of the Dollar and U.S. Current Account Balance, 1980-2001.

16.6 Adjustment Under the Gold Standard FIGURE 16-10 Gold Points and Gold Flows.