Comparative Analysis of Exchange Rate Regimes and Impact on US GDP

This report provides a comparative analysis of different exchange rate regimes, including fixed, floating, and pegged systems, and their effects on the US economy. It examines the advantages and disadvantages of each regime, focusing on how they influence currency fluctuations, trade, and inflation. The report further explores the impact of international trade on the US real GDP, analyzing how net exports, the purchase of foreign goods, and the ownership of foreign companies affect GDP components. It discusses the benefits and costs of international trade, including specialization, productivity, and job creation, while also considering trade restrictions, currency devaluation, and currency wars. The report concludes by highlighting the implications of these factors on the US economy and its international trade policies, referencing relevant economic literature and data.

Running head: COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
Components of GDP and Growth Rates of Real GDP
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1COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
Table of Contents
Question 1........................................................................................................................................2
Fixed exchange rate system.........................................................................................................2
Question 2........................................................................................................................................2
Floating exchange rate.................................................................................................................2
Question 3........................................................................................................................................3
Pegged exchange rate system......................................................................................................3
Question 4........................................................................................................................................4
Question a....................................................................................................................................4
Question b....................................................................................................................................4
Question c....................................................................................................................................4
Question 5........................................................................................................................................4
References........................................................................................................................................8

2COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
Question 1
Fixed exchange rate system
Under fixed exchange rate system, the monetary authority of a nation fixed value of its
currency against another currency or a selected basket of currency or some other standard such
as gold. The authority maintains the fixed rate through open market transaction of its own
currency. If the exchange rate moves far beyond the benchmark limit then government sells
domestic currency and buys foreign currency resulting in a decrease in relative value of the
currency. The reverse is done when value of the exchange falls too below the benchmark limit.
Advantages and disadvantages
The main advantage of fixed exchange rate system is it helps to avoid fluctuation in
currency. The fluctuations of currency increases risk for business dependent on trade (Elfadil &
Ahmed, 2019). Fixed exchange rate by reducing volatility of currency encourage investment and
helps in controlling inflation at a low level.
The benchmark exchange rate may contradict with other macroeconomic goals. Under
fixed exchange rate because of less flexibility of currency it become difficult for countries to
adjust to temporary shocks.
Question 2
Floating exchange rate
Under regime of floating exchange rate, exchange rate of a nation is determined in the
foreign exchange market by the demand and supply of currency in relation to currency of some

3COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
other nations. In contrast to fixed exchange rate exchange rate under floating exchange rate
regime freely float in the market and therefore is subject to continuous fluctuation.
Advantages and disadvantages
Since in a floating exchange rate system exchange rate fluctuates with demand and
supply it helps to ensure stability in the balance of payment system. Unlike fixed exchange rate
system, there is no form of restrictions on foreign capital flow and foreign exchange reserve.
Also, there is no need for monetary authority to maintain large foreign exchange reserve to adjust
the exchange rate.
The main disadvantage of floating exchange rate is that it involves high risk of exchange
rate volatility (Herin, 2019). The exposure to volatility in exchange rate harms business
confidence curtailing growth or economic recovery.
Question 3
Pegged exchange rate system
A pegged exchange rate system is one where government sets its official exchange rate.
This price is set against a major international currency. In order to maintain the pegged exchange
rate government always intervenes the market by buying or selling domestic currency through its
open market operations and maintains sufficient foreign exchange reserve to maintain the set
exchange rate.
Advantages and disadvantages
Countries highly dependent on trade or export prefer pegged exchange rate. Under such a
system country by keeping the exchange rate at a low level boots its competitiveness in the

4COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
international market. This helps to boost export of the nation. This advantage is more prevalent
for countries having low production cost and stronger comparative currency (Uribe & Schmitt-
Grohe, 2017). The kind of exchange rate systems protects the economy from fluctuations in
currency.
Government however has to bear a cost for implementing pegged exchange rate system.
Under pegged exchange rate system government requires huge reserve of foreign exchange. The
massive amount of capital or fund comes with unintended economic consequence such as high
rate of inflation.
Question 4
Question a
The purchase of furniture manufactured in China affects the net export component of
GDP.
Question b
Since the purchase adds to imported items net export obtained as export less import falls.
With a fall in net export, aggregate demand of the economy falls causing a decrease in GDP
(Heijdra, 2017).
Question c
The answer does change if the company in China is a U.S. owned company. In case the
company is US owned its adds to net foreign income from abroad which is not counted under
GDP. It is part of Gross National Product or GNP.
Question 5

5COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
International trade allows a country to specialize in products in which they have a
comparative advantage. By engaging in free trade countries face a lower opportunity cost for
goods which otherwise need to be produced at a higher opportunity cost. US by engaging in
international trade enjoy a gain in terms of higher productivity, output and income (Elson, 2019).
The increased trade in US by increasing productivity of the economy contributed to enhancement
of living standard in US.
Figure 1: Growth of trade as a percentage share of US GDP
(Source: Worldbank.org, 2020)
When countries engage in international trade, resources are utilized in a more efficient
manner. This by increasing productivity of nation stimulates long term growth of a nation.
In contrast to economic gain from trade, countries often bear some costs from engaging
in trade. Free trade is not beneficial in situation if a country with a high production cost has free
trade regime while countries having low production cost does not (Viner, 2016). Another cost is
in terms of displacement of workers from industries in which the countries does not have

6COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
comparative advantage. Although free trade creates both winners and losers overall there is a net
gain from free trade.
International trade also has implication for job creation policy in United States. Export is
generally expected to have a positive influence on jobs and helps to create new job opportunities.
For example, export of wheat led to an increase in job in industries making fertilizer and other
inputs. Jobs are also created because of manufacturing and service sectors. Concerns however
remain because of job losses in the import industries. For example, there is significant loss in
employment in energy sector such as mining or utilities.
United State follows the principle of comparative advantage while engaging in
international trade. US enjoys a comparative advantage because of its capital-intensive labor.
Because of lower opportunity cost US export cars, vehicle parts and other capital intensive
products. In contrast, US imports oil from international mark because of higher opportunity cost
of oil extraction relative to other countries.
Countries typically impose trade restriction on imported products in an attempt to protect
domestic producers from foreign competition. When countries like US imposes tariff, it by
protecting the sector from foreign competition helps in growth of the sector (Amiti, Redding &
Weinstein, 2019) The benefits of tariff also associated with cost of increasing price of imported
items for the domestic consumer. The adverse effect of tariff further worsen when other nations
retaliate.
Currency devaluation by deliberately keeping prices of currency low lowers price of
export while increase price of imports. Devaluation thus supports expansion of international

7COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
trade. Revaluation in contrast raise price of currency and therefore makes exports dearer and
import cheaper for the country.
Currency war or exchange rate war implies a scenario under which different nations in
the world attempt to depreciate domestic currency for boosting their economies. When countries
engage in currency war, it has a possible adverse effect on global trade. This kind of policy
reflects greater protectionism. It by erecting trade barriers may hinders international trade
(Thornton & di Tommaso, 2018).
When trading partners of US manipulates currency it adversely affects US trade. If US is
an exporter, weak currency makes US export expensive and lower export demand. In contrast if
US is an importer then weak currency makes imports cheaper and increases export demand of
these countries in US.

8COMPONENTS OF GDP AND GROWTH RATES OF REAL GDP
References
Amiti, M., Redding, S. J., & Weinstein, D. E. (2019). The Impact of the 2018 Tariffs on Prices
and Welfare. Journal of Economic Perspectives, 33(4), 187-210.
Elfadil, N. H. A. E. A., & Ahmed, I. (2019). Exchange Rate Volatility in Sudan: Does the
Exchange Rate System Matter?. Journal of Finance, 7(2), 1-24.
Elson, A. (2019). Trade Globalization and the US Economy. In The United States in the World
Economy (pp. 43-74). Palgrave Macmillan, Cham.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Herin, J. (2019). Flexible Exchange Rates/h. Routledge.
Thornton, J., & di Tommaso, C. (2018). Unconventional monetary policy and the ‘currency
wars’. Finance Research Letters, 26, 250-254.
Uribe, M., & Schmitt-Grohe, S. (2017). Open economy macroeconomics. Princeton University
Press.
Viner, J. (2016). Studies in the theory of international trade. Routledge.
Worldbank.org (2020) Trade (% of GDP) - United States | Data. Data.worldbank.org. Retrieved
16 March 2020, from https://data.worldbank.org/indicator/NE.TRD.GNFS.ZS?
locations=US