Policy of Nominal Depreciation to Maintain Competitiveness in a FlexNIT Economy

Economic Policy in the Republic of Accelera

A government in an economy with a flexible exchange rate and no explicit inflation target decides to pursue policies aimed at maintaining the unemployment rate below its long-run equilibrium level. Arrange the following economic events into the logical causal sequence that would result from this initial policy decision.

A country operates with a flexible exchange rate and does not have an explicit inflation target. Its government pursues policies that successfully keep the unemployment rate below its natural equilibrium level. This leads to a domestic inflation rate that is persistently higher than the inflation rates of its trading partners. Given this situation, what is the fundamental policy trade-off this country's central bank now faces if it wishes to sustain the low unemployment rate?

Long-Term Viability of a Low Unemployment Policy in a FlexNIT Economy

In an economy with a flexible exchange rate and no explicit inflation target, a government can sustainably maintain unemployment below its equilibrium level by allowing its currency to depreciate, as this depreciation offsets the loss of international competitiveness caused by higher domestic inflation.

The Currency Depreciation Spiral

A government in an economy with a flexible exchange rate and no explicit inflation target pursues a policy to keep unemployment below its equilibrium level. This sets off a chain of economic events. Match each economic phenomenon from this scenario with its most direct cause or consequence.

Evaluating a Policy of Managed Depreciation

A government in an economy with a flexible exchange rate and no inflation target successfully maintains unemployment below its equilibrium level for several years. Initially, a small, steady rate of currency depreciation was sufficient to maintain international competitiveness. Over time, however, policymakers observe that they must allow the currency to depreciate at a faster and faster rate to achieve the same unemployment target. What is the most likely explanation for this need for an accelerating rate of depreciation?

In an economy with a flexible exchange rate and no inflation target, a policy of maintaining unemployment below its equilibrium level creates a cycle of rising prices and currency devaluation. To continuously offset the resulting loss of international competitiveness, the central bank must allow for not just a steady rate of currency depreciation, but an ___________ rate of depreciation over time.