Download Decrease in demand does not lead to currency depreciation Result

LO5
Fixed Exchange Rates
• Add certainty to international trade
• Prevent instability in import and export
industries
• Discourage currency speculation
• Appeal to people who equate exchange rate
with national prestige
© 2012 McGraw-Hill Ryerson Limited
11- 1
Fixed Exchange Rates:
Increase in Currency Demand
LO5
-Increase in demand
does not lead to
currency
appreciation
- Result is a shortage
of Canadian dollars
on world market
- Canadian dollar is
undervalued
© 2012 McGraw-Hill Ryerson Limited
11- 2
Fixed Exchange Rates:
Increase in Currency Demand
LO5
• Increase in demand results in undervalued
dollar, inexpensive Canadian goods
• At fixed rate, more dollars are demanded,
creating a shortage
• To maintain normal trade, Canada must
provide more dollars
• Increased money supply can lead to inflation
• Eventually, Canadian goods become more
expensive, reducing demand for dollars
© 2012 McGraw-Hill Ryerson Limited
11- 3
Fixed Exchange Rates:
Decrease in Currency Demand
LO5
-Decrease in demand
does not lead to
currency depreciation
- Result is a surplus
of Canadian dollars
on world market
- Canadian dollar is
overvalued
© 2012 McGraw-Hill Ryerson Limited
11- 4
Fixed Exchange Rates:
Decrease in Currency Demand
LO5
• Decrease in demand results in overvalued
dollar, causing a surplus on world market
• Supply of foreign currency available for trade
is insufficient
• Central bank’s foreign reserves are depleted
• Eventually, government must take some action
© 2012 McGraw-Hill Ryerson Limited
11- 5
Fixed Exchange Rates:
Decrease in Currency Demand
LO5
Choices for government action include:
1.
2.
3.
4.
5.
Reduce imports through tariffs or quotas
Introduce foreign exchange controls
Negotiate voluntary trade restrictions
Create a recession in Canada
Devalue the currency
© 2012 McGraw-Hill Ryerson Limited
11- 6
Self-Test
LO5
Assume that the demand for the Canadian dollar
increases. Describe the adjustment mechanism to this
change, given:
a) flexible exchange rates; and
b) fixed exchange rates.
© 2012 McGraw-Hill Ryerson Limited
11-7
Self-Test
LO5
Assume that the demand for the Canadian dollar
increases. Describe the adjustment mechanism to this
change, given:
a) flexible exchange rates
b) fixed exchange rates.
© 2012 McGraw-Hill Ryerson Limited
11-8