Getting the Exchange Rate

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Institute of Economic Research, Seoul National University
Seoul Journal of Economics, Vol.1 No.1, pp. 19-40
exchange rate insular economy
Do exchange rate fluctuations increase "justifiable" protectionist pressure?

Despite the existence of highly sophisticated markets for forward exchange, swaps, and currency options, most foreign exchange risk is unhedgeable. A firm making investment decisions today cannot forward sell all its future output, nor contract for most of its future supplies of inputs. Because these forward commodity markets are incomplete, an importer or exporter cannot then utilize the elaborate existing markets in forward exchange to offset most of the risk from future exchange rate fluctuations (Kindleberger (1972)and (1985), McKinnon (1986)).

Among economies highly integrated in trade and finance, therefore, unexpected exchange rate changes provoke protectionism by increasing the riskiness of investment - and deviations from purchasing power parity impede the efficient allocation of capital both nationally and internationally. For example, when the dollar suddenly swung from being undervalued in the late 1970s to being highly overvalued from 1981 to early 1985, many expensive investments in manufacturing, mining and agriculture had to be written off because of America's sharp decline in international competitiveness. In 1985-86 as the Japanese yen has risen sharply against all other major currencies, Japanese industrialists now find their profit margins sharply squeezed - with the threat of a severe investment slump in the offing.
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College of Social Sciences (사회과학대학)Institute of Economics Research (경제연구소)Seoul Journal of Economics (SJE)Seoul Journal of Economics vol.01(1) (Spring 1988)
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