Exchange rate manipulation

Definition

Exchange rate manipulation refers to the deliberate intervention by a government or central bank in the foreign exchange market to influence the value of its currency. This is often done to gain an unfair advantage in international trade by making exports cheaper and imports more expensive, impacting the balance of trade and overall economic competitiveness.

5 Must Know Facts For Your Next Test

1. Countries may manipulate their currency by buying or selling foreign currency to control its value, thus impacting international trade dynamics.
2. Exchange rate manipulation can lead to retaliation from other countries, resulting in trade wars and tariffs, complicating global trade relations.
3. The International Monetary Fund (IMF) monitors exchange rate policies and may impose sanctions on countries that are found to be manipulating their currencies unfairly.
4. Manipulating exchange rates can create short-term economic benefits but may lead to long-term economic instability and loss of investor confidence.
5. It can also affect inflation rates within the manipulating country, as changes in currency value impact import prices and consumer goods.

Review Questions

• How does exchange rate manipulation impact a country's balance of trade?
  • Exchange rate manipulation affects a country's balance of trade by making its exports cheaper and imports more expensive. When a government intervenes in the foreign exchange market to lower the value of its currency, it encourages foreign buyers to purchase more of its products while discouraging domestic consumers from buying imported goods. This can lead to an increase in export volume and a decrease in import volume, thereby improving the balance of trade.
• What are some potential consequences of a country engaging in exchange rate manipulation for international relations?
  • Engaging in exchange rate manipulation can strain international relations as other countries may view this practice as unfair competition. It can lead to retaliatory measures, such as tariffs or trade barriers, from affected nations. Additionally, it might prompt organizations like the IMF to intervene or impose sanctions, further isolating the manipulating country economically. This dynamic creates tension in global markets and can disrupt established trade partnerships.
• Evaluate the ethical implications of exchange rate manipulation on global economic stability and fairness.
  • The ethical implications of exchange rate manipulation raise significant concerns about fairness and global economic stability. By artificially altering currency values, a country undermines free market principles and can disrupt equitable competition among nations. This practice creates imbalances in trade relationships that may benefit one country at the expense of others, leading to increased volatility in international markets. Such manipulation challenges trust in economic systems and raises questions about the responsibility of nations to engage in fair practices that contribute to global economic health.

Related terms

Currency Peg: A currency peg is a policy where a country's currency value is tied or fixed to another major currency, often used to stabilize exchange rates.

Foreign Exchange Reserves: Foreign exchange reserves are the holdings of foreign currencies held by a central bank, which can be used to influence exchange rates and stabilize the national currency.

Devaluation: Devaluation is the reduction of a country's currency value in relation to other currencies, often implemented to boost exports and reduce trade deficits.