The illustration: let's say 1 peso de Fielding = 1 Andyan pound.
Fielding every year is spending 1 peso on imports from Andyland.
Andy is spending 2 pounds every year on imports from Lewisland.
If trade is to balance between Andy and Fielding in the long run, the 1 peso de Fielding will be worth the 2 Andyan pounds.
If exchange rates are flexible, then the price of the exchange will move to 1 peso = 2 pounds. This is a depreciation of Andy's currency due to the sustained trade deficit with Fielding.
(Alternatively, if the exchange rate is fixed at 1:1, Fielding could accumulate Andyan pounds in his central bank, while Andy will deplete any reserves of pesos he has in his central bank.)
Either way, under the flexible or the fixed regime, Andy's currency will come under pressure to move from 1:1 in the long run.
And once Andy's currency depreciates or is devalued, what will happen to Fielding's demand for Andy's exportables? And vice-versa?
No comments:
Post a Comment