Economic Policy and Exchange Rate Regimes - Essay Example

Trade deficit in a country is an economic condition, which results when a country imports more goods than it exports. The deficit is equivalent to the goods imported less the value of the exported goods, and it is given in terms of the currency of the involved country. Measuring the trade deficits is difficult and it involves measuring investment flow for different accounts. These include the financial and the current accounts, which are totalled to get the balance of payments. Current account measures all amounts involved in exporting and importing goods and services, the money transfer between the countries involved, and interests from all the other foreign sources. On the other hand, financial account consists of total changes in ownership at both foreign and domestic level. The net amounts for two accounts are entered in the balance of payments (Agur 2008, p. 67-69). From an economic view, trade deficits characterize poor economies. Most of the countries experiencing trade deficits are involved in consistent borrowing from other countries. Borrowing is not among the viable strategies in businesses. Labour unions consider trade deficits as key contributors to unemployment and it that it undermines the future production (Agur 2008, p. 67-69). The country can run a trade deficit and still maintains the value of its currency through balanced free trade. The trade deficits are usually short-term phenomenon involving restriction of costs and benefits. In short-term phenomenon, the country experiencing the deficit benefits more from exportation than from importation. In long-run, this is the reverse; minimum standard ensures that trade is balanced. The pursuit of individual advantage stimulates the country by rewarding the ingenuity by using the powers bestowed by nature to enhance efficient distribution of labour (Agur 2008, p. 67-69). The country should specialize of efficient production of goods. The balanced trade ensures high standards of living. The interventions by the government distorting the market incentives may be unambiguously harmful. The tariffs limiting the trade may prevent the benefits exchanges. The trade balance means that losses are as a result of the displacement of people by imports (Agur 2008, p. 67-69). A country should also ensure flexible exchange rates in order to prevent the decline of the currency relative to the trade surplus currency from other countries. Regulating the exchange rates ensures that imports are more expensive to reduce the demand on imports. Also, exports should be at relatively low prices to foreigners so as to increase the demand for exports. The country should also aim at maintaining the purchasing power parity and balanced trade (Agur 2008, p. 67-69). Part 2 The Foreign exchange markets are involved with the transactions for national currencies. The existent of such markets is influenced by the incorporation of the national currencies to the economy. In the world, the economy uses different currencies hence the need for the foreign exchange markets. Foreign exchange market is an example of exchange normally used in the international currencies decentralized globally. The financial centers around the world act as anchors for trade between different kinds of buyers and sellers. The foreign exchange markets influence relative value for the different currencies. The parties involved in the exchange markets buy another currency using quantity of another currency (Hutchison 2002, p. 43-45). Under the current conditions, the role of intervention of the foreign exchange markets is limited. Intervention counters the disorderly conditions in the markets and reduces the short term volatility. Intervention normally expresses the attitudes of the exchange markets, and it is useful in supporting and complementing other policies. Most industrialized countries are skeptical towards the foreign exchange markets. They are reluctant in reducing volatility and countering the disorderly market conditions for short-term events. Most of the industrialized countries think that the interventions are not separate instruments for the policies whose effectiveness is supported and complemented by other policies (Hutchison 2002, p. 43-45). Most of the industrialized countries have their overriding objective on the micro-economic policies since their belief that this promotes the achievement of the non-inflationary growth. As a result of the foreign exchange value of their currencies, international investment position and the current account are not considered as policy objectives. The policy makers in such economies lack the instruments that are independent of the fiscal policy and monetary settings. The policy makers account only for the potential development in depreciation of exchange rates as well as the external accounts when balancing risks and making the policies. For instance, in anticipation of the depreciation effects of exchange rate, industrialized countries anticipate the appreciation of the exchange rate and this dampens the economy as well as increasing the possibility of unsustainable external accounts (Truman 2002, p. 102).  Read More