International monetary Essay Example | Topics and Well Written Essays - 1500 words - 1

International monetary - Essay Example This occurs when it becomes impossible to maintain the deficit in the current account. This situation indicates, in general sense, that there will be shortage in the foreign exchange reserves and the particular country is no longer in a position to attract sufficient amount of capital inflows for financing the deficit. For handling this situation of crisis, the government takes measure with the motto of reducing the spending of consumers on imports (Economics Help, 2011). The paper will be presented in a compact manner with the brief explanations about the policies undertaken within the exchange rate regime and alternative approaches and then taking up the interrelationships between the two phenomena along with their critical evaluation. Exchange Rate Regime in Resolving BoP Crisis The approaches under the exchange rate regime are floating, fixed and pegged exchange rate regime. ... r the interest rates and monetary aggregates; whereas in the case of pegged exchange rate system, the central bank does so for achieving stability in price. In case of the floating exchange rate regime, the government does not intervene and the rate is determined by the foreign exchange market itself (Olson & He, 2011). Alternative Approaches in Resolving BoP Crisis The alternative approaches to resolve balance of payment crisis deals with the adjustment mechanisms which can be either automatic or discretionary. Automatic adjustment for resolving BoP crisis takes into account four variables under the fixed exchange rate regime. The variables are prices, interest rates, income and money. The alternative approaches, however, are three schools of thought on the adjustment mechanism. The viability of the three schools of thought that will be discussed in this paper are classical approach (1800s - early 1900s) which was centered around standard of gold and mainly emphasized on interest ra tes and prices, the Keynesian approach (1930s onwards) that emphasized on changes in income affecting adjustment and Monetary approach that emphasized on the role of money in adjustment and changes (Carbaugh, 2005). Viability of Classical and Keynesian Approach with Respect to Exchange Rate Regime The mechanism in the classical approach with respect to price adjustment was that money supply (in terms of gold) was directly related to BoP and BoP deficit would cause the money supply to shrink. This means nations in crisis would lose gold and cause the prices to fall. The lowered prices would result in competitive exports and reduce import demands, thus would restore equilibrium. The problem with this approach is that gold flows are not directly related to domestic supply of money and the