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What conditions are necessary for a devaluation to improve the BOP? Can a small open economy successfully devalue?
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| Submitted: Mon Mar 08 2004
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Nicola James Mary Gregory Week 2: Devaluation What conditions are necessary for a devaluation to improve the BOP? Can a small open economy successfully devalue? Devaluation happens when official action is taken to raise the domestic currency price of foreign currency under a fixed exchange rate environment. Under fixed exchange rates, central banks buy and sell foreign currency to peg the exchange rate. They do this by running down or adding to their reserves of foreign currency. This essay will explore the running of a devaluation and conclude that the Marshall-Lerner condition needs to be satisfied in order for a devaluation to improve the BOP. From the end of WW1 until 1973 many of the major countries in the world had fixed exchange rates. For example in the 1960s, the French central bank, the Banque de France was set at 4.90 FF (French Francs) per U.S. dollar and the German central bank, the Bundesbank...
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