Types of Unemployment and Advantages and Disadvantages of Flexible and Fixed Exchange Rate Regimes

This article discusses the four types of unemployment: frictional, structural, cyclical, and seasonal. It also explores the advantages and disadvantages of flexible and fixed exchange rate regimes. Additionally, it explains how changes in interest rates affect the supply and demand for Australian dollars.

(1) Explain four types of unemployment
Frictional unemployment
Frictional unemployment occurs when there is a change in the economic patterns which affect
the dynamics of labor demand and supply. For example, when there is a decrease in demand for
goods and services, workers specialized for a certain type of work may not be able to find work
that requires that particular type of skill (Hall, 2017). It therefore results to level of
unemployment in a particular industry since as the demand for goods decrease, there is a
decrease in the level of labor demanded. On the other hand, in case there is increase in demand
for another service or product, the labor demand would have increased and therefore a shortage
experienced. Frictional unemployment often results due to the time lags experienced with the
reemployment of labor when the labor market adjusts to changing economic conditions
especially in the short run. For example increase in digital services may lead to a decline in the
need for in line workers in a firm (Pigou, 2017).
Structural unemployment
Structural unemployment occurs when there is a change in demand that stimulates change in
production from one nature to another. Structural unemployment often occurs when there are
long term changes in the structure of the economy. It is therefore unemployment which is caused
through the decline of certain industries as well as the changes in the production process.
Structural unemployment is heightened when there is absence of a neutralizing effect of another
industry picking up when one fails (Falzon, 2017). There results immobility of labor since
workers have skills which are no longer needed in the market. This type of unemployment may

occur when a country’s dominant sector shifts from manufacturing to the service industry. It may
therefore require a shift in the type of skills that people in the market need to have for them to be
able to find jobs (Dosi & Virgillito, 2016).
Cyclical unemployment
Cyclical unemployment occurs when businesses and industries experience the business cycle.
For example, when the economy experiences a contraction, there is likely to be increase in
unemployment as companies size down their labor costs due to decreased demand. On the other
hand, when there is an expansion, there is likely to be a reduction in unemployment because of
the increase in demand which stimulates labor demand. This kind of unemployment affects all
sectors since it is an overall economic event compared to an isolated event based on an industry
(Marinescu & Rathelot, 2018).
Seasonal unemployment
Seasonal unemployment occurs in certain industries such as the hospitality industry, are quite
susceptible to this kind of unemployment. This is because in low season, there is low labor
demand compared to in peak season. Cyclic unemployment is therefore predictable since it
occurs and disappears at fairly regular intervals. Workers in these industries can therefore protect
themselves from the effects of this type of unemployment if they seek work in other industries
which are peak at the time or find permanent work (Van den Berg, 2016).
2. Explain the advantages and disadvantages of:
(a) A flexible exchange rate regime

Advantages
Flexible exchange rates provide the economy with the ability to provide economic stability. It is
able to accommodate changes in the level of a country’s output, level of employment and current
account performance hereby reducing the level of friction in the economic system. A flexible
exchange rate system allows the exchange rates to change in the appropriate direction with
regard to the nature of changes in the economic variables. In the case where international
demand for the local country exports declines, leading to a depreciation in the country’s
currency. A flexible exchange rate is able to remedy the situation by making the goods cheaper
to international markets hence may stimulate demand. On the other hand, a fixed exchange rate
may hinder a similar reaction (Anderson, 2018).
Another advantage is that a flexible exchange rate allows for monetary policy autonomy which
can help the government address policies which deal with inflation and output such as the
desired inflation rates. The monetary policy heavy influences the exchange rate and therefore a
flexible exchange rate is able to respond accurately to monetary policies effected by the
government.
Disadvantages
One of the disadvantages of the flexible exchange rate system is that is exposes the country to
exchange rate risk. The volatile nature of the exchange rates exposes the country to changes
currency fluctuations (Fuller, 2016).
Another disadvantage is increased potential of too much use of an expansionary monetary policy
to remedy economic conditions which may stimulate higher inflationary rates in the country.

Despite the fact that a flexible exchange rate has stabilizing effects towards the economy, those
effects might be questionable. Flexible exchange rates might not be able to change frequently
enough in order to eliminate the current account imbalances leading to misalignments especially
if trade partners have difference in government budgets that is surpluses or deficits. Countries
with deficits may be inclined to impose trade restrictions (McCombie & Thirlwall, 2016).
(b) A fixed exchange rate regime
Advantages
Once advantage of a fixed exchange rate is price stability since the currency is not susceptible to
volatility, it is able to withstand changes in the exchange rate therefore offering stability in price.
Another advantage is a fixed exchange rate regime provides overall economic stability. A fixed
exchange rate is therefore able to shield the country against short run fluctuations through
business cycles.
A fixed exchange rate leads to a reduction of uncertainty in the international trade since people
do not have to speculate on the level of exchange rates to make market moves.
Through a fixed exchange rate, a country can be able to establish an automatic balance of
payment adjustment mechanism which will be able to maintain internal and external balance. For
example, if the country has a current account surplus and the goods are more expensive to the
international market, the fixed exchange rate can reduce the current account surplus in the home
country and reduce the current account deficit from the foreign markets.

Further, the country can also make a symmetrical adjustment of the monetary policies. For
example, in the case of an increase in the money supply, there is a reduction in the interest rates
which increases capital inflows.
Disadvantages
While the fixed exchange rates can promote price stability, it may lead to fluctuations in the
average price level. For example, if the currency is pegged on gold, the fluctuations may be
caused by the changes in the relative price of gold compared to the price of goods and services.
Also, while the fixed exchange rate may lead to economic stability and prosperity, it may lead to
economic slow downs in the event contractionary policies are implemented which lead to
reduced country outputs and higher unemployment rates (Obstfield & Qureshi, 2018).
In the case the fixed exchange rate is pegged on the reserve currency standard, the price specie
flow mechanism may not be affected, especially when countries with high levels of current
account deficits experience problems repaying their loans from countries with surpluses.
In addition, fixed exchange rates may lead to the importation of other countries unemployment
and inflation rates. In the case there is an increase in the inflation rate, the consumers may
increase the demand for foreign goods hereby increasing the prices in other countries (Engel,
2016). In addition, when the country also experiences lower levels of output growth, it is able to
purchase less from other countries hence having an adverse effect on the other countries level of
outputs.
Further, reliance on a fixed exchange system leads to an increase in the precious metal reserves
that the country needs to hold. The downside in this is that the central banks may not be able to
increase their levels of gold reserves as their economies grow. It may lead to the increase of the

need to sell domestic assets to purchase gold which may decrease money supply and affect
output and levels of employment (Sassen, 2018).
Another disadvantage is that the fixed exchange rate may potentially have an influence of the
macroeconomic conditions in counties which produce the precious metal standard. For instance,
increase demand for the precious metal may lead to increased money supply in the producing
country which may lead to increased inflationary rates in the country. Conversely, the decrease
in demand for the precious metal may lead to reduced economic output in the producing country.
3. Suppose the Reserve Bank of Australia increases the interest rate. What happens to the
supply and demand for Australian dollars? Does the dollar appreciate or depreciate?
Explain with words and a diagram
In the case the Reserve Bank of Australia increases interest rates, the country will experience
capital inflows in the country (Mimouni, 2017). There will be increase in demand for the local
country currency. Increase in demand for the local country currency will lead to an appreciation
of the currency. An appreciation of the currency may make the goods in the local market more
expensive than foreign goods leading to inflation which may reduce the economic output.
Reduction in the economic output may increase the levels of unemployment in the county. Also,
the government may experience an increase in the borrowing costs in the country (De Grauwe,
2018).

P2
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