Microsoft Word - hw516f
November 3 Egypt abandoned its peg to the dollar and allowed the Egyptian pound to float (flexible exchange rate). The value of the currency depreciated more than 50 percent compared to the value a week earlier. A primary motivation was the fact that Egypt was experiencing a severe shortage of dollars with a thriving black market, and the central bank was on track to run out of reserves in a few months. In addition, the policy change was also a condition to receive a loan from the International Monetary Fund, and on November 11 Egypt?s central bank received $2.75 billion from the IMF to increase its foreign currency (dollar) reserves. The change in policy has been controversial, with some commentators predicting social unrest, but it generally has been applauded by economists.
Read the news articles regarding this policy change posted on the course webpage:
And write a short essay (about 500 words) to analyze this scenario using the theories we learned in class. Please address the following questions:
1) Use the theories of the foreign exchange market studied in class to explain why Egypt had a currency black market and reserves shortage under the exchange rate peg, and why this shortage become more sever recently. (You should consider possible sources of external imbalance, and the role of expectation in the foreign exchange market). How will allowing the currency to float resolve the shortage of reserves?
2) Using the macroeconomic theories studied in class, what are the macroeconomic tradeoffs in adopting this policy? Why do some commentators fear social unrest? Why do many economists applaud the new policy? (Make use of the logic of the ISLM model, and draw comparisons with at least one currency crisis studied in class.)
Running head: EGYPT ECONOMY 1 Egypt Economy
Institution EGYPT ECONOMY 2
Egypt Economy Black currency market, refers to a pool of businesses that are engaging in business
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