Background
An under-valued currency implies that its exchange rate with other currencies is lower than what is needed for maintaining *external balance. Countries may find themselves with an under-valued currency due to various economic conditions, deliberate policy actions, or market speculations.
Historical Context
Historically, the valuation of a currency has been pivotal in shaping a country’s international trade dynamics and financial strategy. Instances of currency devaluation have had critical implications for global trade and have often been central in debates concerning fair trade practices.
Definitions and Concepts
An under-valued currency is characterized by an exchange rate that is lower than its implied value based on purchasing power parity (PPP) or other indicators that suggest an equilibrium rate. This leads to cheaper exports for the issuing country, stimulating their sales abroad, and making imports from other nations more expensive.
Major Analytical Frameworks
Classical Economics
Classical economists might interpret an under-valued currency in terms of real prices and the gold standard, focusing on intrinsic factors affecting supply and demand for that currency.
Neoclassical Economics
In neoclassical models, an under-valued currency could result from market imperfections, government intervention, or asymmetric information.
Keynesian Economic
Keynesians might argue that an under-valued currency could serve as a stimulus by boosting aggregate demand through enhanced export competitiveness.
Marxian Economics
From a Marxian perspective, an under-valued currency might be seen as a tactic by capitalist states to exploit global labor by diverting true value through manipulated exchange terms.
Institutional Economics
Institutional economists would consider the role of international organizations, trade agreements, and regulations in potentially leading to the sustained under-valuation of a currency.
Behavioral Economics
Behavioral economists may investigate how irrational investor behaviors and speculative bubbles can cause currencies to become under-valued.
Post-Keynesian Economics
Post-Keynesians might focus on the role of financial markets and the endogeneity of money in creating and sustaining under-valued currencies.
Austrian Economics
Austrians would emphasize the importance of sound money and critique institutional interventions that distort true currency value.
Development Economics
Development economists might examine how an under-valued currency can aid emerging economies in boosting their industrial and export-led growth.
Monetarism
In monetarist theory, an under-valued currency could be analyzed in terms of money supply, interest rates, and international reserves management.
Comparative Analysis
Comparing various economic schools of thought provides a diversified understanding of the causes and impacts of an under-valued currency. The interplay of these views encapsulates the potential advantages such as trade flow improvements and disadvantages including possible inflationary pressures within the domestic economy.
Case Studies
- China’s Renminbi (RMB): Historically accused of deliberate under-valuation to boost exports.
- Japan Yen (1990s): Post-bubble period where the Yen was considered under-valued impacting its exports positively.
Suggested Books for Further Studies
- “Exchange Rate Determination” by Michael R. Rosenberg
- “International Economics” by Paul Krugman and Maurice Obstfeld
- “The Economics of Exchange Rates” by Lucio Sarno and Mark P. Taylor
Related Terms with Definitions
- External Balance: A state where a country’s current account is in equilibrium, not leading to significant surpluses or deficits.
- Balance of Payments (BoP): A record of the economic transactions between residents of a country and the rest of the world in a particular period.
- Current Account: Part of the BoP, encompassing trade balance, net primary income, and net unilateral transfers.
By understanding under-valued currency, its definition, frameworks, and case studies, economists and policymakers can better navigate the complexities of international economics and trade.
