Does depreciation or devaluation (by the way, they mean different things) always work to correct a BOP or Current Account Deficit??
Well, assuming Marshall Lerner condition applies, it works – but only in the long term.
Why does this happen?
Let’s take the example of Singapore, which buys raw materials from China, and sells the finished products to USA.
China and Singapore
Let’s say before depreciation of Sing dollar, the exchange rate was 5RMB to 1SGD; after the depreciation, it was 4RMB to 1SGD.
This means that previously, 1SGD can buy 5RMB worth of goods, but now? Only 4RMB. There is a decrease in the external value of Sing dollar.
Still, due to contractual obligations, Singapore firms must continue buying from China until the contract expires. Furthermore, the Chinese will still want to be paid at 5RMB – the previously agreed upon terms. (It’s a bit like giving tuition to foreign students – no matter what the exchange rate in their country is, high or low, the tutor still gets the same fixed, agreed upon fees.)
But previously, Singapore firms were forking out only 1SGD for 5RMB, now they have to fork out 5/4*1 = 1.25 SGD instead – to buy the SAME AMOUNT OF RAW MATERIALS from China.
Imagine Singapore firms paying Chinese partners SGD 1m in the past – that means a whopping 1.25m now! Another $250,000 more! Due to depreciation!
THIS APPLIES TO THE IMPORT SECTOR OF S'PORE! THUS THE DEMAND FOR IMPORTS IS PRICE INELASTIC IN THE SHORT RUN
Singapore and USA
Let’s say before depreciation, the exchange rate was 1SGD to 0.75 USD; after the depreciation, it was 1SGD to 0.5 USD.
The Americans need to pay so much less in order to pay us the same 1SGD (remember, they always pay us in SGD – and to do so, they convert their currency into our currency).
Buying goods from Singapore is so much cheaper now for Americans. Obviously, they are going to demand more since lower prices mean A LOT MORE quantity demanded (it’s technically called more than proportionate – remember, I assumed ML condition holds).
But the problem is, it takes time for the new contracts to be drafted, and it also takes time for the Singapore firms to pool resources e.g. hire more people to meet the new orders (in short run, supply is inelastic).
THIS APPLIES TO THE EXPORT SECTOR OF S'PORE! THUS THE SUPPLY OF EXPORTS IS PRICE INELASTIC IN THE SHORT RUN
So that means, in the short term:
1) We are converting more Singapore dollars to pay China, honouring our contractual obligations.
2) We are still selling the same amount of goods to USA, hence getting the same number of Sing dollars (not more).
Obviously there will be a worsening in the current acc deficit in the short run.
In the long run, however, Singapore firms will be negotiating to decrease raw materials costs (or changing the Chinese suppliers to find cheaper alternatives), and increasing the output to meet new demand from USA.
Thus, assuming Marshal Lerner condition holds, depreciation will improve current account deficit, but only in the long run.
Special thanks to aceitall.wordpress.com
Labels: my life as a student
(back to the top.)
I was flabbergasted when Macus told me that TPJC JC2s will not join the JC1s in celebrating national day like what all schools did on Friday. They are seriously damn scared of their current batch doing badly for the 'A' levels where they implement the 7pm-9pm structured revision period for those doing badly.
Well..SRJC is also kiasu but not to that extent. We hold our 3rd Thanksgiving concert on Friday in conjunction with the national day celebrations. Even though the early morning math lesson was unnecessary as all it does is spoil our day, we are expected to be in school by 5pm. As expected.. we are late, AGAIN. This time is my fault because I met Haikal late at his bus stop. Mr Nahar gave me a good dressing down about my late-comings and attitude problems but hey, i don't give a damn about what you think about me Mr Nahar.
When we were slowly ushered into the hall, it was like walking into a night club. The school invited some IT professionals to set up the hall and the sound systems was like in a club and the atmosphere with the dimmed lights and stuffs. They even played club songs like "Boom boom pow" and "Just Dance". The concert was a blast, the GP and Lit dept performance of "And all the Jazz" was sweeet and also the Humanities dept was the cutest! Super Mario and Sonic was damn epic, I WANT THAT MARIO SUIT HAHA.
The Science and PW dept performance was one of my favourites too. Which performance I don't like ah? The PE and the Math dept. Seriously are they taking this concert seriously like the other dept? After the concert was photo-taking time and everyone was snapping away with their best friends,teachers and loved ones. I took a few only as I don't know where the rest of our class went to and thanks to someone who pushed me to ask someone for something, I am going to treasure it ;)
Labels: my life as a student
(back to the top.)
Demystifying the J curve effect
Monday, August 10, 2009