1. Devaluation can be used to boost an economy’s output and local spending and also increase its stock of foreign reserves. However, such a technique is popularly known to be a one-time type. Such results will only be obtained if the devaluation happens only once. If the players in the foreign market suspect a second devaluation in the near future, they will react differently with the first devaluation. Devaluation causes an increase of the real exchange rate, making imports more expensive as compared to local products. This boosts the local economy shifting the IS curve to the right.
The increase of output causes the quantity of money demanded to rise. To increase the money supply, the central bank purchases foreign exchange reserves also to maintain exchange rate. This advantageous occurrence to the local economy, however, is not beneficial to players in the foreign market since their products will not be competitive in that particular economy. Therefore, if they suspect that a similar occurrence will happen in the near future, they will see to it that their economic interests will be protected or advanced even such that they can choose to act differently after the first devaluation.
For example, the foreign economy can choose to change its exchange rate such that the local economy cannot buy enough or too much of their currency. This will make the local economy unsuccessful in replenishing its reserve of foreign currencies even after the first devaluation. If an economic strategy is beneficial to an economy but not to another, then if that strategy becomes known to other player, a counter policy or approach can be employed such that the other player can protect his own interests too. 2.
Increasing economic efficiency and maximizing productivity have always been the goal of any economy. If an expansionary monetary is expected to be carried out by the new government, then measures that will yield this productive will start to be carried through. This expectation will greatly affect the economy’s exchange rate since expansionary monetary policy will only be effective in increasing its total expenditure or output if the exchange rate it employs is flexible. Under a fixed exchange rate, an expansionary monetary policy will not be efficient in enhancing the economy’s productivity and output.
In whatever way the economy chooses to move its capital; be it perfectly mobile or mobile capital, or an immobile capital, its result together with a monetary policy will be the same: and that is, having no effect at all. Therefore, if the economy would like to have its expansionary monetary policy effective, it will have no other choice but to opt for a flexible exchange rate. Under a floating rate, however, the capital is made to move, an increase in economic efficiency and output will always be observed.
Even if the capital is perfectly mobile, or immobile, as long as the exchange rate is flexible, a monetary policy will enhance economic output. References Open Economy Macroeconomics: The IS-LM-BP Model. (n. d.). Retrieved from http: //www2.econ. iastate. edu/classes/econ302/alexander/fall2003/openeconmacro/openeconomymacroeconomics. pdf Yarbrough, B. & Yarbrough R. (2006). The World Economy: Open-Economy Macroeconomics and Finance (7th ed. ). In: Thompson/South-Western College.