Exchange rates can be understood as the price of one currency in terms of another currency. However, just like for goods and services, we must take into account what determines that price, since governments can influence it, and even fix it. Exchange rate regimes (or systems) are the frame under which that price is determined. From a purely floating exchange rate, to a central bank determined fixed exchange rate, this Learning Path explains the basics of each of these regimes.

We’ll start by learning about the concept itself, and will continue with each regime type, starting with the ones with highest monetary policy independence, and moving to less independent regimes.
Definition:

Exchange rate regimes, a simple definition and a list of types.

High independence:

Flexible exchange rate, with two different subtypes:

Free (clean) float, where market forces determine the price;

Managed (dirty) float, when some governmental intervention happens.

Decreasing independence:

From higher to lower monetary policy independence, we have:

Crawling peg, Target zone arrangement, Fixed exchange rate, and Currency board.

Low independence:

No separate legal tender, such as dollarization.

Monetary union, such as the Euro zone.

Inflation and unemployment can be very harmful to the economy, and so governments will always try to control them by implementing economic policies. However, knowing how a problem originates is always helpful when trying to fix it. This is the reason why economists have created an incredible amount of theories and economic models that try to explain how these inflation and unemployment behave.

In this Learning Path we’ll take a look at a few economic models that explain, at least to some extent or in some given context, inflation and unemployment.

NCM’s view:

NCM, an economic doctrine that appeared in the early 1970s;

NCM’s Phillips curve, which incorporates rational expectations;

Cahuc’s adjustment costs model, which analyses adjustments in employment levels.

NKE’s view:

NKE, which appeared in the late 1970s, and focused on the analysis of inflation;

NAIRU, the non-accelerating inflation rate of unemployment;

Layard-Nickell NAIRU model, based on wage determination.

Prices and growth:

Menu costs are costs that result from price changes;

Mankiw’s menu costs model, Gregory Mankiw’s view on the issue;

Business cycles, which also explain the level of unemployment.

There is a relationship between inflation and unemployment that can be easily analysed. Governments around the world take this relationship very seriously, since there will always be a trade-off when implementing economic policies aiming either at reducing unemployment or keeping inflation at bay. Even though this relationship was first analysed by Alban William Housego Phillips in 1958, it has since evolved, taking into consideration adaptive and rational expectations.

In this Learning Path, we’ll learn about the Phillips curve and how expectations have made it evolve.

Early developments:

Phillips curve, which shows the relationship between inflation and unemployment;

NRU and NAIRU, two different views of the unemployment at equilibrium.

Monetarist view:

Adaptive expectations, using past expectations to form present ones;

Expectations augmented Phillips curve.

NCM’s view:

Rational expectations, introducing future predictions;

NCM’s view of the Phillips curve, a newer version.

Inflation and unemployment are probably, along with GDP, two of the most used economic indicators of how well a country is doing. Inflation measures increases in the price levels, which can hurt the economy in multiple ways when not under control. Unemployment measures the percentage of people in a country that, being able to work, are unemployed. Both are to be carefully measured, in order for governments to be able to keep them under control.

In this first Learning Path of our series on inflation and unemployment, we’ll learn about what these two concepts are, and how to tackle them.

Definitions:

Inflation, a continuous general rise in the level of prices;

Unemployment, what it is and how to measure it.

Government policies:

Economic policies, steps taken by governments to fix the economy;

Fiscal policy, when government uses public finances;

Monetary policy, when banks use special tools to kick-start the economy;

Supply-side policies, aimed at increasing the productivity of a country.

Nowadays, pretty much every country in the world is considered to be an open economy. This means that the country will trade with the rest of the world, these exchanges being measured in terms of net exports. When analysing open economies, it is important to understand a few things about the countries being analysed, such as the volume of trade they have, their economic growth, their inflation and unemployment rate, etc.

An economy’s openness must be measured considering multiple variables. For instance, all countries are considered open economies to some degree, but not all allow free movement of capital across borders. Others might have governments that control information flows and Internet service. In this Learning Path, we’ll learn to analyse an open economy from a purely economic point of view, looking at their net exports and their Balance of Payments.

Balance of Payments:

Balance of Payments, which reflect the transactions between an open economy and the rest of the world;

Current account, shows the value of net exports;

Capital account, reflects net foreign holdings of capital;

Financial account, the net acquisition and disposal of financial assets and liabilities.

Foreign markets:

IS-LM, which focuses on the equilibrium of the market for goods and services;

IS-LM-BP, same as before, but taking into account international trade;

Net capital outflows, which analyses purchases of foreign and domestic assets;

The market for loanable funds, a simplified view of the financial system..

When we study macroeconomics, the easiest and first approach is to analyse closed economies. These are defined as countries that are self-sufficient and autartik, meaning they do not trade with other countries, and rely only on what they produce. There is a widely used analogy by Economics professors: Robinson Crusoe’s island. If we think about it, Robinson Crusoe was unable to trade, and its consumption and production were closely related. This one-man economy is the easiest way to understand closed economies.

In this Learning Path we’ll learn about basic concepts needed in the study of macroeconomics. The use of a closed economy is for simplicity’s sake.

Getting to an equilibrium:

Supply and demand, probably the two most important concepts in Economics;

Market clearing, or how the equilibrium is reached;

Cobweb model, a strange yet realistic phenomenon.

The IS-LM model:

John Maynard Keynes, considered as the father of macroeconomics;

John R. Hicks, which made further developments to Keynes works;

IS-LL model, Hicks’ model derives from Keynes’ “General Theory”;

IS-LM model, an improved IS-LL model, widely known nowadays.

Economists study macroeconomics as a way to understand how the world works, and how to analyse any country’s economy . In other words, in contrast to microeconomics, which analyses a consumer or a firm’s economy, macroeconomics analyses the economy as a whole. Therefore, to understand how the economy of a country works, we must understand various macroeconomic indicators, as well as national accountings (used to measure a country’s growth), unemployment rate, inflation, etc.

In this Learning Path, we’ll see the basic concepts needed to start studying any country’s economy. Even though the analysis should start by assuming either a closed or open economy, this LP omits such concepts, and gives just the very basic notions required to study macroeconomics. Think of this LP as an introduction to all other LPs in our series on Macroeconomics.

An introduction:

Macroeconomics, a basic definition of what it is;

Circular flow diagram, an easy way to understand how an economy works.

GDP and its components:

Gross domestic product, what it measures and why it’s so important;

Consumption, the main component of GDP;

Investment, which is volatile and unpredictable;

Government spending, and ways in which it is used;

Net exports, which considers exchanges between the economy and the rest of the world.