What happens to the current account balance right after the oil price shock and after the government stops supporting the currency? What items of the current account are likely to change and why? b. How is the market for non-tradables in the domestic economy affected in these two stages? c. What will the IMF likely ask the government to do as a condition for providing it with the emergency loan? What justifications are there for these IMF conditions? Why are these conditions highly unpopular politically?
What happens to the current account balance right after the oil price shock and after the government stops supporting the currency? What items of the current account are likely to change and why? b. How is the market for non-tradables in the domestic economy affected in these two stages? c. What will the IMF likely ask the government to do as a condition for providing it with the emergency loan? What justifications are there for these IMF conditions? Why are these conditions highly unpopular politically?
Chapter1: Taking Risks And Making Profits Within The Dynamic Business Environment
Section: Chapter Questions
Problem 1CE
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refer to the photo and answer the following
a. What happens to the current account balance right after the oil price shock and after the government stops supporting the currency? What items of the current account are likely to change and why?
b. How is the market for non-tradables in the domestic economy affected in these two stages?
c. What will the IMF likely ask the government to do as a condition for providing it with the emergency loan? What justifications are there for these IMF conditions? Why are these conditions highly unpopular politically?
Transcribed Image Text:Country X is a major oil exporter. It has a floating exchange rate system and has managed to
maintain current account surpluses for some time, which it used to build up its foreign exchange
reserves over the years. Oil prices suddenly fall from around $100 a barrel to $29 a barrel in the
course of a single year, making a huge dent in the country's ability to earn foreign exchange
from its exports. The government first considers the drop in oil prices temporary and decides to
draw down its reserves to finance the emerging deficit in its current account and to support the
country's currency. However, domestic and foreign investors, seeing a looming currency crisis
and an eventual depreciation of the country's currency start converting their assets into foreign
exchange and pulling their money out of the country, putting further pressure on the value of the
country's
s currency, but the government continues to support the currency by using its vast
reserves.
Eventually, as the reserves begin to run low, the government acknowledges that the oil price
declines are durable and changes tack by no longer using its reserves to purchase the local
currency to shore up its value. A rapid depreciation of the currency occurs, leading to a spike in
domestic inflation and causing further downward pressure on the value of the currency and
further inflationary pressures. Faced with a continuing foreign exchange crisis and depleted
reserves, the government of county X approaches the IMF for an emergency loan. As a condition
for the loan, the IMF demands that the country undertake further stabilization measures to
stabilize the macro economy and adjust to the new reality of lower oil prices.
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