Impact of Exchange Rate Adjustments and Its Effects on the Balance of Payment
The persistency and size of a country’s imbalance payments whether surplus or deficit and the adjustment needed to correct it, depends upon the exchange rate system used. There are two types of exchange rates.
1. Floating or Flexible Exchange Rate, the supply and demand of the currency determines the rate the countries will exchange. No involvement of the Government takes place. Example of floating exchange rate is US Dollar.
2. Fixed or Pegged Exchange Rate, this system is dominated by the Governments of countries managing the rates at ...view middle of the document...
The country can lower the relative prices by allowing its exchange rates to depreciate in the free market or by deliberately devaluing its currency by Government intervention.(R.J. Carabaugh, 2011)
For example, China in the past years has shown a surplus in balance of payments, this has majorly been due to the Chinese currency exchange rate being undervalued. China uses the fixed or pegged system; this depreciation causes the lower cost, and lower price of manufactured goods eventually increasing the exports and sales. With the domestic or local production being at lower price too, the consumption of local products increases, thus decreasing the imports.
The lower exchange rate is beneficial to the economics of a country as
* Providing ways to improve competitiveness,
* Reducing export prices,
* Increasing the import prices,
* With a fixed rate, the government interferes for currency manipulation.
R.J. Carabaugh, 2011. International Economics. In R.Carabaugh, International Economies, Cengage Learning.
Investopedia, 2013. Retrieved from http://www.investopedia.com/articles/03/020603.asp
National Bureau of Economic Research, 2002, Working Paper, exchange rates and adjustment:
Perspectives from the new open economy macroeconomics Retrieved from