Sample Essay

The Chinese government has shown that it is to attempt to determine an exchange rate through planning and to keep it contained within narrow defined margins over a long term. While China initiated a program of slowly making its foreign exchange regime more flexible and agreeing to allow incremental appreciations of its currency, these may not be substantial enough to divert the pressure it is experiencing. Further exchange rates flexibility would solve a classical conflict between the internal and external balance under the tight currency peg arrangements (OECD, 2008:80).

Traditional textbook macroeconomic theory suggests that appreciations in the currency are contractionary in the short term. A rise in the exchange rate increases prices of locally produced goods relative to imported ones which lead to a decline in the exports of the country and a rise in imports as the consumers now see their prices falling. This has the tendency to reduce aggregate demand in the economy which is not good for the local industry.

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