The effects of Devaluation and unemployment

The effects of Devaluation and unemployment

In a country’s Economy

 

Introduction

An unemployed person is a person who belongs to the civilian labor force who is willing and available for any chances of employment in his line of profession or liking, has worked for wages of less than an hour per week and is actively involved in searching for employment. Unemployment reduces when the economy grows and picks up an increasing trend which creates opportunities for new entrants to be absorbed in the labor market but a few will certainly be left without jobs. A country can pursue expansionary policies to correct trade imbalances and control inflation. Other countries use different kinds of monetary policies to achieve their desired economic growth.

Provide an overview of the case and summarize the key points

Unemployment and its effect on the economy.

Devaluation is a monetary policy or process that means reduction in a currency’s value with respect to those goods, services or other monetary units or standards with which the currency is exchanged or reducing the value of a country’s currency or legal tender within a limited or fixed exchange rate system. Revaluation is the opposite of devaluation. (Sullivan, Sheffrin, 2003).

Higher unemployment rates has a way of generating its own feedback loop, when people have less amount of money to spend and the general demand falls across the country’s economy, then employed people agree to take pay cuts to retain their jobs and the earnings drop. Despite the improvement in the economy and the subsiding inflation, prices seem to rise more quickly than the wages. (Keynes, 2007)

The effect of devaluation in country’s economy – Argentina.

Argentina is one of the countries in South America. In the year 1900 it had the best economies in the world. Following the great Latin debt crisis in the beginning of the year 1982, Argentina never recovered fully from it. For seven years it struggled had but had very little success. Its GDP fell by 7% while inflation was at its worst at 3080%. Many politicians and great economist tried their best but none of them could contain the inflation nor control the recession. In the year 1991 one of its experiments to control the economy succeeded. The country adjusted its dollar rate to be at par with the dollar, that’s 1:1. Argentina restricted introduction of more money into the economy. A new board was created to oversee the currency exchange rate and its circulation that ensured that for every peso circulating in the economy it was matched by a corresponding dollar to check the value of its currency. This system worked and till the year 1998 when the great global fallout from the eastern Asian countries spilled to Latin America hitting their economies hard. Brazil, a major trading block for Argentina, devalued its currency making all their products cheaper compared to Argentina. Argentina’s balance of balance of payments run into a 5% deficit and the loss triggered another recession in the year 1999. The country’s expenditure was down partly because its products were expensive and its exports were below average, the country should have taken monetary steps to curb the recession i.e. reduce taxes, increase government spending and the supply of money, plus other relevant  monetary steps to stem the recession. But Argentina took so long to notice that the 1:1 dollar exchange rate to the dollar was now hurting the economy instead of strengthening it. The dollar on its own accord found its balance among the world currencies and the Argentina’s peso had dropped to 0.27 pesos per dollar in the year 2002 and eventually it settled at less than 25% of its original value. Many economists argue that had Argentina devalued its currency much earlier, then it would have avoided a lot of losses to its economy.( Krugman and Obstfeld, 1999)

Explain why a currency devaluation, whether intentional or not, would be a problem.

When there is a global recession, the demand of goods and services are low and countries struggle to escape the adverse effects of recession. One of the solutions is to devalue the country’s currency. Its major problem is that it may create inflation but during a recession then these effect will not be felt. But countries that devalue their currencies gains by becoming more competitive than the one that does not. Which creates the perceptions that the losing country is being targeted? It can have a bad impression on central bank as it may be viewed as being political and overstepping its mandate and authority in trying to manipulate the country’s exchange rate. A retaliatory tariff can be charged against the country if a disadvantaged country feels it was wrongly targeted by the devaluation procedures. The devaluation measures can result in loose monetary policy which may lead to inflation in future.

Consider the question: Does this mean that developing countries cannot use expansionary macroeconomics policies? Provide an answer to this question.

Expansionary policy is a macroeconomic policy that is designed to expand and increase the supply of money in the economy to encourage faster economic growth and combat inflation which is characterized by price increases. Expansionary macroeconomics policies can be used and applied in developing countries to check inflation and control recession. The devaluations that happened in Argentina were ineffective because they were instituted late but if they could have been implemented earlier like in the case of Brazil, then the effects of the recession would have been reduced significantly.

To conclude, every country literally wants a currency that’s not so strong so that it can export to a strong country. If the currency is weak compared to other currencies, then the goods exported will be very competitive abroad which will lead to increased GDP, employment and general trade. A weakened currency will also make it easier for a country to repay its debts as the currency was stronger then. People are also motivated to spend more domestically because of the belief that the money will reduce its value in future and as such it’s better to spend while it’s valued more. But these expansionary policies may also lead to inflation or other complications like reduced employment in the long run.

  

References

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