Exchange rate manipulation

Definition

Exchange rate manipulation refers to the intentional actions taken by a government or central bank to influence the value of its currency in the foreign exchange market. This can involve buying or selling currencies to maintain a desired exchange rate, which can provide competitive advantages in international trade and impact the balance of payments.

5 Must Know Facts For Your Next Test

1. Governments may manipulate their exchange rates to keep their exports cheaper and imports more expensive, boosting domestic industries.
2. Exchange rate manipulation can lead to trade tensions and disputes between countries, as it may be perceived as an unfair trade practice.
3. The International Monetary Fund (IMF) monitors countries for potential exchange rate manipulation through its surveillance activities.
4. Long-term exchange rate manipulation can result in economic imbalances and vulnerabilities in the affected economies.
5. Countries with significant reserves can more easily manipulate their currency values by buying or selling currencies in large volumes.

Review Questions

• How does exchange rate manipulation affect a country's trade balance?
  • Exchange rate manipulation directly impacts a country's trade balance by making its exports cheaper and imports more expensive. By devaluing their currency, governments can encourage foreign buyers to purchase more domestic goods, which helps improve the trade surplus. Conversely, if a country keeps its currency artificially high, it could lead to a trade deficit as imports become more attractive due to lower prices.
• Discuss the potential consequences that a country may face if it is accused of engaging in exchange rate manipulation.
  • If a country is accused of exchange rate manipulation, it may face significant consequences such as tariffs or trade sanctions imposed by other nations. These actions can lead to diplomatic tensions and retaliatory measures, potentially harming the manipulated economy. Additionally, international organizations like the IMF might intervene, requiring the country to adjust its policies, which could destabilize their economy and financial markets.
• Evaluate the long-term economic implications of sustained exchange rate manipulation for both the manipulating country and its trading partners.
  • Sustained exchange rate manipulation can lead to various long-term economic implications for both the manipulating country and its trading partners. For the manipulating country, while short-term benefits like increased exports may be seen, over time it can create economic distortions and vulnerabilities, such as inflation or reduced competitiveness. For trading partners, persistent manipulation may lead to retaliation or shifts in global trade dynamics, as they may seek to impose tariffs or seek new trade agreements that counteract the effects of manipulation.

Related terms

currency peg:

A currency peg is a policy where a country's currency value is tied or fixed to another major currency, such as the US dollar, to stabilize its exchange rate.

devaluation: Devaluation is a reduction in the value of a currency with respect to other currencies, often executed by the government to enhance export competitiveness.

trade surplus: A trade surplus occurs when a country's exports exceed its imports, leading to an inflow of foreign currency and potentially influencing its exchange rate.