In order to understand how various currency exchange rate policies could implement to improve macroeconomic reforms and overall economic growth and strength we need to examine the features of the following primary exchange rate systems: crawling peg, fixed, free-floating, or market-based approach. Each system has distinct implications for economic stability, inflation control, and overall economic performance. Here's a detailed analysis of each policy for foreign exchange rate policy in the context of macroeconomic growth and development.
In the current unstable peace and security situation in Ethiopia, implementing a market-based or free-floating system or other policies is not straightforward simple and has not had a significant impact on macroeconomic policy in short-period. Despite the fact that, the market based rate may it allows central bank some intervention to manage volatility and stabilize the currency, which is crucial in an environment where external and internal factors that can lead to substantial economic fluctuations. However, on the current trends the success of this approach depends on the central bank's ability to implement effective policies and maintain transparency and credibility amidst ongoing security concerns.
1. Crawling Peg
A crawling peg system involves pegging a currency to another a basket of currencies, but with periodic adjustments (often gradual) to account for inflation differentials or economic conditions. Thus, the National Bank of Ethiopia follows this method before new reforms are applied, free-floating or market-based currently. The Implications of this rating system for Ethiopia economy as follows: i) Flexibility with Stability: This system allows for some stability (because it is pegged) while offering flexibility through gradual adjustments. For Ethiopia, this could mean a balanced approach where the currency is stabilized against a major currency (like the USD or EUR) but adjusted periodically to respond to economic changes. ii) Inflation Control: The crawling peg can help manage inflation by preventing sharp devaluations. This policy could provide a buffer against severe currency fluctuations for Ethiopia, which has struggled with high inflation. iii) External Shocks: Ethiopia could still face challenges from external shocks. While the system offers more flexibility than a fixed peg, it might not be as robust in the face of sudden or large economic disturbances. iv) Implementation and Credibility: The success of a crawling peg depends on the credibility of the central bank’s commitment to periodic adjustments. Ensuring transparency and maintaining investor confidence is crucial.
2. Fixed Exchange Rate
In a fixed exchange rate system, the currency’s value is pegged to another major currency or a basket of currencies, and the central bank intervenes in the forex market to maintain the fixed rate. The Implications of this rating system for economy relies on the following. Stability: A fixed exchange rate provides stability and predictability, which can be beneficial for trade and investment. Stability in Ethiopia could attract foreign investment and trade by reducing currency risk. Inflation and Reserves: Maintaining a fixed exchange rate requires a significant amount of foreign exchange reserves. Insufficient reserves could make it challenging for Ethiopia to manage fluctuations in the demand and supply of foreign currency. Monetary Policy Constraints: Ethiopia's central bank may face challenges in using monetary policy to stabilize the domestic economy and in adjusting interest rates to control inflation or respond to economic shocks. Risk of Speculative Attacks: If the fixed exchange rate is unsustainable, it could lead to devaluation or a shift to a more flexible system due to speculative attacks.
3. Free-floating exchange Rate
In a free-floating exchange rate system, the value of a currency is determined solely by market forces without intervention from the central bank. The National Bank of Ethiopia (NBE) has chosen to use a market-based exchange rate system, which is a hybrid influenced by market forces but may involve central bank interventions to manage volatility or target specific economic outcomes. The implications of this rating system for Ethiopia economy as follows:
Market Efficiency: A free-floating system allows for automatic adjustments to economic conditions, potentially reflecting the true market value of the currency, benefiting Ethiopia if well managed.
Policy Space and Volitility: The central bank has control and can intervene to reduce excessive volatility or address specific economic conditions, such as extreme inflation or deflation. In a floating exchange or market-based rate system, currency values can fluctuate significantly, leading to uncertainty for businesses, investors, and increased risks for international trade in Ethiopia. Shortly, current trends and high uncertainty associated with the country's security issues influence the implementation of proper reforms in one way or another.
Inflation Control: The central bank can focus on inflation control without needing to maintain a specific exchange rate. However, during times of high inflation, a free-floating system may worsen inflationary pressures due to currency depreciation.
Balance Between Stability and Flexibility: This system offers stability while incorporating market forces, providing a middle ground for Ethiopia between fixed rates and free-floating rates.
Transparency and Predictability: Transparency in interventions is crucial. Market-based systems can boost confidence with predictable and well-communicated central bank actions.
Economic Adjustments: This system may better adapt to changing economic conditions, easing Ethiopia's implementation of gradual reforms while managing economic pressures.
External Shocks: The economy may be more vulnerable to external shocks, such as fluctuations in global commodity prices, which could impact currency value and overall economic stability.
Eventually, NBE after using a crawling peg for a long time, has now by shifting, its policy to a free-floating or market-based approach by devaluing the currency or Birr value almost by 30 percent. Additionally, the results of the current reform show that in less than a week, Ethiopia's currency, the Birr, lost over 90 percent of its value.
Conclusion
Each exchange rate policy has distinct advantages and challenges. When considering Ethiopia’s macroeconomic reforms for foreign exchange policy the issue of uncertainity of the peace and security influence the economic reforms. Therfore, the exchange rate system choice depends on stability, flexibility, managing inflation, and external shocks of the country. NBE is Crawling Peg exchange rate by shifting into floated or market-based systems, chosen in line with prudential macroeconomic goals that align with both macroeconomic stability and financial stability including institutional capacity, and the need for credibility and growth in particular. Therefore, for impactful economic reform and for genuine outcomes, all sectors, including public, private, and other stakeholders, must be approached and exercised optimistically and ethically.
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