The Case against Floating Exchange rates Destabilizing Speculation and Money Market Disturbances Floating exchange rates allow destabilizing speculation Countries can be caught in a vicious circle of depreciation and inflation Advocates of floating rates point out that destabilizing speculators ultimately lose money Floating exchange rates make a country more vulnerable to money market disturbances Figure 19-2 illustrates this point Copyright C 2003 Pearson Education, Inc Slide 19-11
Copyright © 2003 Pearson Education, Inc. Slide 19-11 ▪ Destabilizing Speculation and Money Market Disturbances • Floating exchange rates allow destabilizing speculation. – Countries can be caught in a “vicious circle” of depreciation and inflation. • Advocates of floating rates point out that destabilizing speculators ultimately lose money. • Floating exchange rates make a country more vulnerable to money market disturbances. – Figure 19-2 illustrates this point. The Case Against Floating Exchange Rates
The Case against Floating Exchange rates Figure 19-2: A Rise in Money Demand Under a Floating Exchange Rate Exchange rate, E DD E AA1 AA2 Output, Y Copyright C 2003 Pearson Education, Inc Slide 19-12
Copyright © 2003 Pearson Education, Inc. Slide 19-12 AA1 DD Output, Y Exchange rate, E E1 Y1 1 Figure 19-2: A Rise in Money Demand Under a Floating Exchange Rate AA2 E2 Y2 2 The Case Against Floating Exchange Rates
The Case against Floating Exchange rates Injury to International Trade and Investment Floating rates hurt international trade and investment because they make relative international prices more unpredictable Exporters and importers face greater exchange risk International investments face greater uncertainty about their payoffs Supporters of floating exchange rates argue that forward markets can be used to protect traders against foreign exchange risk The skeptics replied to this argument by pointing out that forward exchange markets would be expensive Copyright C 2003 Pearson Education, Inc Slide 19-13
Copyright © 2003 Pearson Education, Inc. Slide 19-13 ▪ Injury to International Trade and Investment • Floating rates hurt international trade and investment because they make relative international prices more unpredictable: – Exporters and importers face greater exchange risk. – International investments face greater uncertainty about their payoffs. • Supporters of floating exchange rates argue that forward markets can be used to protect traders against foreign exchange risk. – The skeptics replied to this argument by pointing out that forward exchange markets would be expensive. The Case Against Floating Exchange Rates