Types of Unemployment, Advantages and Disadvantages of Flexible and Fixed Exchange Rate Regime, Impact of Interest Rate on Currency

This article explains the four types of unemployment, advantages and disadvantages of flexible and fixed exchange rate regime, and the impact of interest rate on currency. It includes references from various authors such as Mankiw, Krugman and Wells, Koutsoyiannis, McConnell, Brue and Flynn.

MACROECONOMICS
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Question 1
The four types of unemployment are as explained below.
 Structural Unemployment – This unemployment tends to arise when there is a change
in the economy owing to which the underlying skills for employment are altered. As a
result, the previous skills are rendered redundant and the individuals who are not able
to acquire the requisite skills to work in the new economy, tend to become
unemployed. In order to bring them back into the employment fold, government
intervention through requisite training and job assistance is required (Mankiw, 2014).
 Frictional Unemployment – This refers to the temporary phase of unemployment
which tends to arise when individuals tend to make a shift from one job to other. In
this process, there is a time lag owing to the time required to search a suitable job and
to get selected and during such period, the concerned individual remains
unemployment. This is part of natural unemployment and does not require
government intervention (Krugman and Wells, 2014).
 Cyclical Unemployment – The demand for labour tends to fluctuate based on the
underlying economic growth. Since economic growth tends to follow cycles, hence
during a recessionary phase, there is a decrease in the demand of various products and
services which tends to reduce the capacity utilisation and hence the demand for
labour. As a result, some employees may be fired owing to lower production level
desired coupled with focus on lowering costs. In case of severe cyclical
unemployment, government intervention is required in order to enhance demand and
stimulate economic growth which automatically would resolve the cyclical
unemployment owing to increase in demand for labour (Koutsoyiannis, 2013).
 Seasonal Unemployment - This type of unemployment as the name suggests is
seasonal whereby during the lean period for a particular profession, there would be
unemployment while during the peak season the concerned individual would be
employment. This is quite prevalent amongst individuals who are engaged in various
primary activities where seasonal aspect is the most prominent. Another industry
where seasonal unemployment occurs is tourism which may be concentrated only in
the holiday season or when the tourists tend to arrive (McConnell, Brue and Flynn,
2014).
Question 2

a) The various advantages of flexible exchange rate regime are indicated below (Mankiw,
2014).
 Flexible exchange rates tend to act as automatic stabilisers. Hence, if the currency
depreciates, the exports become more competitive which in the medium term should
lead to currency appreciation. Similarly, if the currency appreciates, then imports
become cheaper and hence in the medium term leads to depreciation pressure on the
currency.
 Flexible exchange rates tend to allow for autonomous monetary policies. The nation
adhering to flexible exchange rate system can have independent long term inflation
target based on underlying economy and aim to have the policy aligned with the same
without paying attention on the prevalent exchange rate. Having said that, it is critical
to note that monetary policy and exchange rate are inter-dependent.
The various disadvantages of flexible exchange rate regime are indicated below
(Koutsoyiannis, 2013).
 The exchange rate tends to be volatile owing to which there is significant exchange
rate risk with regards to exporters, importers and also foreign investors.
 Owing to existence of an independent monetary policy, it is possible that there may be
a general inflationary pressure that could be created on account of overdoing
expansionary monetary policy for growth promotion.
 The empirical data does not lend too much support to the automatic stabilising as the
trade deficit or surplus does not alter frequently.
b) The various advantages of fixed exchange rate regime are indicated below (Krugman and
Wells, 2014).
 There is stability in the current exchange rate which augers well for the various
players such as importers, exporters and also the foreign investors.
 If the exchange rate is linked to some stable currency as USD, then the inflation rate
also remains lower owing to the lower inflation witnessed in the base currency.
 Even when there are changes in the exchange rate, it provides suitable warning for the
various stakeholders to adjust and thereby avoiding the uncertainty.
The various disadvantages of fixed exchange rate regime are indicated below (McConnell,
Brue and Flynn, 2014).

 One key issue of maintaining fixed exchange rates is the high cost associated whereby
a high amount of foreign exchange is required to be maintained so as to keep the
value of current constant.
 Also, there may be conflict within the various macro objectives as maintaining the
exchange rate is one of objectives which may not be compatible with other objectives.
As a result, at times, the interest rates would have to be raised in order to maintain the
currency price.
 Such a regime may lead to a artificial unbalancing of current account as is visible in
case of China.
Question 3
If the RBA increases the interest rate, then the amount of foreign money that would flow into
Australia would increase so as to invest in the debt securities which would offer a higher
yield and hence become more attractive for these foreign investors (Krugman and Wells,
2014). In order to invest money in Australia government securities and bond, the underlying
currency would be AUD and hence the foreign currency would have to be first changed into
AUD. As a result, there would an increase in the demand for AUD so that more money can
be invested in the debt market. This is represented in the diagram shown below
(Koutsoyiannis, 2013).
In the above diagram, owing to increased demand of AUD, the demand curve has shifted to
the right i.e. D1. The supply in the short run for AUD remains the same. The net result is that
there is an appreciation in the price of AUD with regards to the foreign currency. This is
apparent from the shift in equilibrium position as indicated in the graph (Mankiw, 2014).

References
Koutsoyiannis, A. (2013) Modern Macroeconomics. 4th ed. London: Palgrave McMillan.
Krugman, P. and Wells, R. (2014) Macroeconomics. 3rd ed. London: Worth Publishers.
Mankiw, G. (2014) Principles of Macroeconomics. 6th ed. London: Cengage Learning.
McConnell, C., Brue, S. and Flynn, S. (2014) Macroeconomics: Principles, Problems, &
Policies. 20th ed. New York: McGraw Hill Publications.