Question

suppose we have a country w/ fixed exchange rate regime. the country just experienced a natural disaster (SRAS curve shift inward).

a) should they devaluate or revaluate their currency to resolve inflation issue?

b) what would the country do with its currency?explain and show on graph (w/ exchange rate on y-axis, countries currency in x-axis)

Answer 1

for a country with fixed exchange rate system firstly we draw a graph so as to know the equilibrium rate of exchange and how much currency is demnaded and supplied t each price.

we get eq rate of exchange at the interesection of demand and supply curves, on the vertical we usually have the price of currency or the exchange rate of economy, whereas on the horizontal axis we have quantity of country' currency.

thus at the intersection we get an equilibrium rate of exchange.

Secondly, as there is a natural disaster and sras curve shifts inward implying supply curve shifting inward thus there would be a change in determination of equilibrium rate of exchange.with the inward supply curve shifting from ss to s1s1 we find that at the intersection proce has risen and quantity of currency falls.

thus leading to inflation in he economy( because of rising prices).

resolving inflation issue country needs to devaluate because already currency has been overvaluated.

b) in order to resolve the lying inflationary pressure of currency in the country. country need to increase the supply of country,s currency, being not a one step process, suplly of currency increases slowly ans slowly back to the initial level of equilibrium.

PLEASE NOTE:

figure 1 a represents basic fixed exchange rate situation , whereas 1b shows up the affect of disaster.