The exchange rate of a country measures the external value of the currency. To a country such as Zambia the market for foreign exchange is very important. Its own currency, the kwacha is not a hard currency and thus not universally accepted in payment of debt. Zambia relies on generating foreign currency from selling exports to enable it to finance imports. The macroeconomic situation such as the balance of payments position, employment and inflation are all influenced by a country’s exchange rate. Hence it becomes a key economic policy inconsistent.
Exchange Rate
The price of one compared to another countries currency. If you have one exchange rate i.e. USD = $1.00 and the Euro Dollar =$1.3087 you would get .31 cents for every US dollar.
Fixed exchange rate
Is a rate system where the value of the currency against another currency remains exactly the same? In order for the rate to remain fixed governments have to hold large stocks of foreign exchange so they can interfere in order to hold the currency firm. (Bized, 2011)
Floating exchange rate
Is a currency exchange rate that is determined by the sellers and the buyers that does not have government interference? (Bized, 2011) If a country has a floating exchange rate system the outside value of the currency is permitted to find its own value against other currencies. (Bized, 2011) Plot the value of the kwacha measured in terms of the US$ between: 1965 and 1980 and 1990 and 1998.
In 1998 it appears that the Kwacha dominated as there is no data for the US$. Would you describe the change in the exchange rate of the kwacha between 1980 and 1995 as an appreciation or a depreciation? What is your reason for thinking this? I think the Kwacha appreciated in the exchange rate. My reasoning is due to the elevated dollar amount of the exchange is higher. Why did the government of Zambia want to maintain a fixed exchange rate for the kwacha? The countries government acted through its agent which was the Central Bank. (Bized, 2011)
The government was following a policy of import exchange and industrialization at this time prior to 1991. (Bized, 2011) The Zambian government wanted control over the exchange rate. In 1964 the Zambian government adopted the fixed exchange rate regime with the British Pound which was the anchor. (Economics Association of Zambia, 2010) Using supply and demand analysis how a government could fix the value of the currency at an official exchange rate. Use the axes below to illustrate your analysis.
Bized, 2011 During much of the period from Independence there has been a black market for dollars in Zambia. Would you expect a black market for dollars to develop in Zambia during a floating or fixed exchange rate regime? Why? Yes, in such a situation of a parallel or dual black market for foreign exchange usually develops with a fixed or floating exchange rate. Due to this black market foreign currency is usually bought illegally at an exchange rate which is far more than the actual exchange rate. (Bized, 2011)
It depends as there were no black market rates for the year 1970 & 1998 respectively. If we are comparing 1980 & 1991; than 1991 would have the greatest percentage difference. The dual rate in 1991 was a political motivated move due to the Copperbelt food riots. (Mungule, K., 2004) The dual-exchange rate regime was established as a two-tier system the official rate of K28/$1 was managed by a float initially at K40/$1. (Mungule, K., 2004) This system lasted about 1 year.
In 1992 when the government of President Chiluba introduced a floating exchange rate and abolished exchange controls there was considerable capital flight out of Zambia. What is meant by capital flight?
Capital flight is the movement of financial assets out of a country in response to an adverse domestic circumstance. (Bized, 2001) It can be explain as a large number of individuals and organizations exchange domestic currencies for US dollars in order to leave the countries. (Peng, pp. 102) Using supply and demand analysis explain the impact of capital flight on the value of the kwacha against the dollar. The real GDP averaged at about -0.6% per year and this performance was worse than the past 5 years. (Mungle, K. 2004) The gross domestic investment to GDP and the gross domestic savings to the GDP continued to decline. (Mungle, K. 2004) Zambia during this time accumulated a total debt of US$6.595 million at the end of 1995. (Mungle, K. 2004)
When a currency depreciates the fear is that it may lead to inflation. Why is this? When currency depreciates most time it does lead to inflation. Currency typically does not depreciate unless the prices of goods and services within an economy rise over a period of time. (Want2rich, 2011) This means the purchasing power of the country’s currency depreciates. (Want2rich, 2011) Plot the values of the exchange rate and the inflation rate between 1980 and 1998. Describe and explain the relationship between the two sets of data. Does it support the idea that depreciation could contribute to causing inflation? Yes, look at the period between 1989 and 1993, the consumer price index more than doubled in this time period.
A fall in the value of a currency will bring about a change in the prices of exports and imports. Changes in export and import prices will in turn cause changes in the quantity of exports and imports demanded and consequently the balance of payments of current account. Plot the data for the exchange rate of the kwacha and the current account balance. Can you find any evidence to support either of the following?
The idea that devaluation leads to an improvement in the balance of payments situation In 1990 the balance of payments due to the inflation was extremely in a deficit balance. b) The Marshall Lerner condition
This is a change in the exchange rate of a country’s currency which lead to improvement or decline of a country’s balance of payments. (Bized, 2001) Explain, using the concept of price elasticity of demand, how the exchange rate changing affects the balance of payments of current account. It is the percentage change in quantity demanded of a certain product divided by the percentage of change in the price. (Tutor2u, 2012) Changes in price and quantity always move in opposite directions, economists usually do not hassle by putting in the minus sign. (Tutor2u, 2012) Most economists are concerned with the co-efficient of elasticity of demand. (Tutor2u, 2012) Step 4
Suppose the members of the COMESA decided to form an economic union and introduce a single currency. You may find it helpful to review the COMESA case study in the trade tour and also look at the theory on the formation of Trading Blocs. Outline the advantages for a single regional currency and one outlining the disadvantages of such a currency to the economy of Zambia.
Advantages
Trading blocs have some advantage of keeping a single currency because of free trade. (Bized, 2001) Allowing free trade by lowering individual trade barriers is also an advantage of a single currency. (Bized, 2001) If the country’s currency is a hard currency it will be accepted by other countries as a form of payment. (Bized, 2001) Disadvantages
The impact of such trade barriers can have a negative impact as well. Trading blocs can create a trade diversion effect as well. (Bized, 2001) The kwacha is not considered a hard currency which is not universally accepted as a form of payment. (Bized, 2001) Could there ever be a world currency? Give the reasoning for your decision. Yes, I believe there could be a world currency. By the development of the Euro which is widely accepted in many countries as a form of payment. (Answers, 2006) Most world economies today depend on other nations for economic support and trade of some form. (Answers, 2006) To take a first step in global unification must be the incorporation and enforcement of a single world currency. (Answers, 2006)
References
- Economics Association of Zambia, The Volatility of the Exchange Rate: A Case of the Zambian Kwacha, (2010), from www.eaz.org
- Mungule, K., The determinants of the real exchange rate in Zambia, The University of Zambia, (2004), from www.aerafrica.org
- Peng, Global, Student Edition, (2010) Bized, Development Glossary (A-C), [ Biz/ed Virtual Developing Country ], (2001), from http://www.bized.co.uk/virtual/dc/resource/glos1.htm#c
- Want2rich, Understand Finance, Inflation: a worry for retail investors as it reduces investment options and return, (2011), from http://www.want2rich.com/2011/05/personal-finance/inflation-a-worry-for-retail-investors-as-it-reduces-investment-options-and-return/
- Tutor2u, Essential guidance on economics exam technique: AS Markets & Market Systems, Price Elasticity of Demand, (2012), from www.tutor2u.net/economics.html
- Bized, COMESA, The Common Market for Southern and Eastern Africa (COMESA), (2001), from http://www.bized.co.uk/virtual/dc/trade/comesa/issue1.htm
- Bized, Introduction, (2001), from http://www.bized.co.uk/virtual/dc/works/ers.htm Answers, Yahoo, Will there ever be a one world currency? Or how about an end to currency?, (2006), from http://answers.yahoo.com/question/index?qid=1006041403652
