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Chapter 13: Problem 2

Three major approaches to analyzing the economic impact of currency depreciation are (a) the elasticities approach, (b) the absorption approach, and (c) the monetary approach. Distinguish among the three.

Short Answer

Expert verified
The elasticities approach assesses impact by viewing effects on the trade balance through price elasticity of goods, the absorption method views currency depreciation as an adjustment mechanism between domestic output and absorption, while the monetary approach argues that currency depreciation is driven by monetary variables such as money supply and demand, and exchange rates. Each approach is applicable to different scenarios based on the country's economic landscape.

Step by step solution

01

Defining Each Approach

Start by expanding each methodology. For the elasticities approach, this model uses price elasticities of domestic and foreign goods to gauge how depreciation influences the balance of trade. The absorption approach views currency depreciation as a method to adjust the difference between domestic production and domestic absorption. Lastly, the monetary approach links currency depreciation to monetary factors, such as money supply, money demand, and exchange rates.
02

Highlight Key Differences

The primary distinction amongst these is primarily based on the variables they focus on. Elasticities approach concentrates on price elasticities and how they influence trade balance. The absorption approach emphasizes the adjustment of the balance between domestic output and absorption. The monetary approach, on the other hand, stresses the role of monetary variables.
03

Examples and Additional Differences

It will help to illustrate each approach with examples or scenarios. Additional attention could be given to each approach's pros and cons, or conditions where a certain approach would be more suitable to apply. For instance, the elasticities method could be more applicable to economies with significant export and import fluctuations, while the absorption method might be more applicable to countries with large production-consumption gaps, etc.

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Most popular questions from this chapter

According to the absorption approach, does it make any difference whether a nation's currency depreciates when the economy is operating at less than full capacity versus at full capacity?

How can currency depreciation-induced changes in household money balances promote payments equilibrium?

Assume that the United States exports \(1,000 \mathrm{com}\) puters costing \(\$ 3,000\) each and imports 150 U.K. autos at a price of \(£ 10,000\) each. Assume that the dollar/pound exchange rate is \(\$ 2\) per pound. a. Calculate, in dollar terms, the U.S. export receipts, import payments, and trade balance prior to a depreciation of the dollar's exchange value. b. Suppose the dollar's exchange value depreciates by 10 percent. Assuming that the price elasticity of demand for U.S. exports equals \(3.0\) and the price elasticity of demand for U.S. imports equals \(2.0\), does the dollar depreciation improve or worsen the U.S. trade balance? Why? c. Now assume that the price elasticity of demand for U.S. exports equals \(0.3\) and the price elasticity of demand for U.S. imports equals \(0.2\). Does this change the outcome? Why?

What is meant by the Marshall-Lerner condition? Do recent empirical studies suggest that world elasticity conditions are sufficiently high to permit successful depreciations?

What implications does currency pass-through have for a nation whose currency depreciates?
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