Floating Exchange Rates Internal Balance Multiple Chapters

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In addition, floating exchange rates may also give the government some flexibility with respect to the consumption function. The current issue with Greece and the euro illustrates this. Greece needs to spur economic growth in order to build a current account surplus that will help it to pay off its debt. In a floating exchange rate regime, Greece could do this by reducing the value of its currency, making Greek exports cheaper on world markets. This would bring in the necessary foreign capital. The Greek government, however, does not have control over its exchange rate as a member of the Eurozone. As such, it has no such flexibility to spur export growth. Indeed, Greek products are overpriced on the world market because costs in Greece are out of line with its economy. Although the euro is a floating currency, for the Greek government it is not because it cannot exert any real control over its movements. Thus, Greece is stuck with a high exchange rate that prohibits export growth, leaving the entire external and internal economy out of equilibrium.

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As a result, the Greek economy is not going to have full employment any time soon. Indeed, because the crisis has been spurred by government debt, the government cannot increase spending to prop up domestic demand. Greece, by virtue of not having a currency whose float it can control, now lacks its two most powerful policy levers and therefore is powerless to bring its internal economy into balance.

The Greek example illustrates clearly the role that a floating exchange rate plays in the ability of government to bring an economy into balance. Fixed exchange rate regimes lack this lever, and thus have a more difficult time bringing the currency into balance should such action be required. In addition, because the exchange rate is fixed, it is more likely to be out of equilibrium in the first place, which only serves to compound the problem......

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