Macroeconomics 1

This article covers four types of unemployment, advantages and disadvantages of flexible and fixed exchange rate regimes, and the relationship between interest rates and exchange rates in Macroeconomics 1. It discusses how frictional, cyclic, structural, and seasonal unemployment occur and how flexible exchange rates promote economic development, monetary policy autonomy, and international trade. It also explains how fixed exchange rates provide currency stability, prevent currency depreciation, and promote responsible macroeconomic policies. Finally, it explores the relationship between interest rates and exchange rates and how the Reserve Bank of Australia's interest rate increase affects the Australian dollar exchange rates.

Macroeconomics 1
ECO202 –Macroeconomics
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Macroeconomics 2
Question 1. Four types of unemployment
i. Frictional unemployment
This type of unemployment occurs when individual take time to move from one job to
another. In frictional unemployment, individuals are usually between jobs or are
graduates who have just completed university or college and are looking for a job.
This type of unemployment is normally short-lived in nature(Garcia-Murillo,
MacInnes and Bauer, 2015).
ii. Cyclic unemployment
Cyclic unemployment occurs when the economy has not reached its full capacity.
People in this type of unemployment are usually laid off due to a decline in demand
for their products and they are looking for another job(Diamond, 2013). This type of
unemployment is generally temporary in nature. For instance, during recession
periods, the demand for durable products like houses and cars usually decreases.
People in these industries normally lose their jobs until the demand rise again(Garcia-
Murillo, MacInnes and Bauer, 2015).
iii. Structural unemployment
This type of unemployment results due to mismatch of knowledge and skills in the
labor market. In structural unemployment, people lose jobs and start looking for other
jobs because of technological advancement or any other structural changes in
production(Lindbeck, 2015). For example, due to outsourcing where companies locate
their companies abroad to overcome competition, many workers often become
structurally unemployed. This type of unemployment is usually permanent in nature
iv. Seasonal unemployment
This type of unemployment usually occurs due to seasonal changes. People often
become unemployed and start looking for new jobs during the off seasons(Diamond,
2013). For example, workers working in ice cream vendors may lose their jobs during
the winter seasons due to a decrease in demand.
Question 2a Advantages of a flexible exchange rate regime
a) Monetary policy autonomy
In flexible rates regime, countries can establish autonomous monetary policies to
address output and inflations problems. Since monetary policies affect inflation rates,
under flexible exchange rates regime, nations can create their long-run inflation rates

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without necessarily importing inflation rates from their trade partners(AL-Thumairi,
2012).
b) Promotes economic development
Flexible exchange rate systems help the country to achieve full-time employment of
its citizens and promote the economy. This is due to the fact that, the exchange rates
can be changed in accordance with the needs of the nation in terms of monetary
policy in order to achieve national goals(Azcona, 2017).
c) Promotes international trade
Flexible exchange rates regime does not permit exchange control thus promotes free
trade. International trade restrictions are removed and there is free movement of
money and capital between countries.
Disadvantages
a) Potential exchange rate risks
Flexible exchange rates systems are volatile as changes in exchange rates are
larger and more frequent than the underlying fundamentals suggests(Amalia
Morales-Zumaquero and Sosvilla-Rivero, 2014).
b) Low elasticities
The elasticities in the global markets may become too low for exchange rates thus
making the exchange market unstable.
c) The potential for too much use of the expansive monetary policy.
For a country to be able to create autonomous monetary policies, it must first be
able to establish higher inflation rates. Flexible exchange rates can lead to
inflationary and recessionary pressures due to contractionary and expansionary
monetary policies(Dellas and Tavlas, 2013).
Advantages of Fixed Exchange rates regime
a) Provide currency stability
A fixed exchange rate regime provides currency stability. Fixed exchange rates
system promote foreign investors making the nation’s businesses attractive. This
is due to the fact that investors do not try to protect themselves from a change in
currency value(Azcona, 2017).

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b) Fixed exchange rates systems strengthen the economy of a country. As the
country grows, its currency does as well. Due to use of flexible exchange rates by
other countries, their currencies are subjected to drop. As a result, the importation
of such countries to a country that practices a fixed exchange rate regime becomes
more expensive leading to imports inflation(A. Morales-Zumaquero and Sosvilla-
Rivero, 2014)
c) Adoption of responsible macroeconomic policies. Stable fixed exchange rates
prevent the country from adopting irresponsible macroeconomic policies. For
instance, a country may develop fixed exchange rates regimes may help a country
to develop policies to deal with the balance of payment deficits even without
changing the domestic policies(AL-Thumairi, 2012).
d) Prevent currency depreciation
Poor developing countries experience a permanent balance of payment
difficulties. Any change in exchange rate will lead to a balance of payment crisis
which may result do depreciation of currencies. This can be prevented by the
adoption of fixed exchange rates.
Disadvantages
i) A fixed exchange rates regime can make a country to be targeted by speculators.
They can artificially bring a short thus making the currency value to go down. If
the central bank does not convert its exchange rates to go up, the interest rates will
automatically go up thus causing a recession(Amalia Morales-Zumaquero and
Sosvilla-Rivero, 2014).
ii) Fixed exchange rates systems are normally expensive to maintain. A country must
have adequate foreign exchange reserves in order to maintain the currency
value(Azcona, 2017).
Question 3
If the Reserve Bank of Australia increases the interest rates, with all other factors held
constant, then the Australian dollar is likely to appreciate(Tafa, 2015). This means that the
Australian dollar value will increase as compared to other countries that offer lower interest
rates. Higher interest rates tend to attract foreign investors thus the demand of Australian
dollar will increase(Tafa, 2015). As monitored by the demand and supply curve, the supply of

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the Australian dollar will drop as many investors will be competing to secure a place for
investments(Kunnumpurath and Julien, 2018).
Below is a graph that shows how demand and supply of Australian dollar will be affected
when the Reserve Bank of Australia increases the interest rates ( X-axis represent quantity
and Y-axis represent price)
5 10 15 20
0
5
10
15
20
25
Supply curve
demand curve
As demonstrated by the demand and supply curve above, if the Reserve Bank of
Australia increases the interest rates, the Australian dollar exchange rates will go as high as
the value of the Australian dollar will increase. This will make its price to be high thus its
supply will lower. The movement along both the demand and supply curve will move to the
left.

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References
AL-Thumairi, I. a. (2012) ‘Fixed Exchange Rate or Flexible Exchange Rate for Saudi Arabia:
optimal solution of CGE model’, International Journal of Basic and Applied Sciences,
1(January 2006), pp. 67–87. doi: 10.14419/ijbas.v1i2.29.
Azcona, N. (2017) ‘Exchange rate policy and the role of non-traded goods prices in real
exchange rate fluctuations’, The B.E. Journal of Macroeconomics, 17(2). doi: 10.1515/bejm-
2015-0185.
Dellas, H. and Tavlas, G. (2013) ‘Exchange rate regimes and asset prices’, Journal of
International Money and Finance, 38. doi: 10.1016/j.jimonfin.2013.05.008.
Diamond, P. (2013) ‘Cyclical unemployment, Structural unemployment’, IMF Economic
Review, 61(3), pp. 410–455. doi: 10.1057/imfer.2013.13.
Garcia-Murillo, M., MacInnes, I. and Bauer, J. M. (2015) Techno-Unemployment?, SSRN.
doi: 10.2139/ssrn.2588160.
Kunnumpurath S. and Julien, N. (2018) ‘Global Supply and Demand of Opioids for Pain
Management’, Current Pain and Headache Reports, 22(5), p. 34. doi: 10.1007/s11916-018-
0689-1.
Lindbeck, A. (2015) ‘Unemployment: Structural’, in International Encyclopedia of the Social
& Behavioral Sciences: Second Edition, pp. 738–743. doi: 10.1016/B978-0-08-097086-
8.71021-X.
Morales-Zumaquero, A. and Sosvilla-Rivero, S. (2014) ‘Real exchange rate volatility,
financial crises and exchange rate regimes’, Applied Economics, 46(8), pp. 826–847. doi:
10.1080/00036846.2013.859382.
Morales-Zumaquero, A. and Sosvilla-Rivero, S. (2014) ‘Real exchange rate volatility,
financial crises and exchange rate regimes’, Applied Economics, 46(8). doi:
10.1080/00036846.2013.859382.
Tafa, J. (2015) ‘Relationship between Exchange Rates and Interest Rates: Case of Albania’,
Mediterranean Journal of Social Sciences. doi: 10.5901/mjss.2015.v6n4p163.

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