Wednesday, 27 April 2011

Explain the concept of a "Soft Currency"

A hard (or strong) currency is one that can be used to trade internationally and that is a stable store of value. Hard currencies are normally present in politically and economically strong countries, with stable government and low inflation. It is expected that hard currencies will not depreciate in value against other currencies, as this would be a characteristic of soft currency.

Soft currencies, conversely, are the opposite of hard currencies. A soft currency is expected to de-value compared to over time and is normally the currency of developing countries such as Zimbabwe. The Zimbabwean dollar was a good example of a soft currency, as their inflation rates were as high as 3714% per year, which was in part due to, and in part led to the printing of money. Currencies such as the Zimbabwean dollar are rarely used for international trade or for keeping large stores of.

There were fears at first that the euro would be a soft currency, but such fears were not realised and this is probably no surprise - given the nature of the economies who use it as well as the highly specific entry requirements. There also seems to be quite effective management of the currency by the European Central Bank. Their interest rates are higher than those set by the central bank in the UK, and eurozone growth is higher than that in the UK, which puts the EU in a better position than ourselves. Also, the ECB clearly doesn't want any countries to drag the currency down, such as Portugal, as they are choosing instead to take very drastic measures such as bailouts as well as setting strict fiscal policy guidelines to those countries that fail to manage their own economies successfully.

7 comments:

  1. "There also seems to be quite effective management of the currency by the European Central Bank. Their interest rates are higher than those set by the central bank in the UK, and eurozone growth is higher than that in the UK"

    Surely the high interest rates in ECB would slow growth and also the low interest rates in the UK would spur growth?

    In which case, why the different growth rates and/or why the different interest rates?

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  2. It's true that the high interest rates in the ECB should dampen growth, but i'm saying it shows the economic strength of the eurozone that it can have positive growth and keep the interest rates high in order to control the price level (which in the UK is currently inflating at 4%)

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  3. If interest rates were lower, though, wouldn't unemployment (about 9.5% in Eurozone - but much higher in Spain, for example)fall?

    Why is there a worry about unemployment if inflationary pressure is high?

    If inflationary pressure is not high then why have high interest rates?

    If the interest rates are high won't this keep the Euro high and thus further worsen the unemployment figure?

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  4. When both inflation and unemployment are high, it is known as "stagflation". There was a fear that the UK was entering stagflation as its unemployment is currently around 10% and all signs were suggesting that inflation would rise (low interest rates etc..) Luckily, our inflation fell in the latest figures released which means fears of stagflation hopefully won't be realised.

    Even if inflationary pressure is not high, the eurozone tends to keep abnormally high interest rates in order to keep inflation lower than some argue it should as it doesn't have a symmetrical inflation rate target. This means that there is not equal emphasis on raising the interest rate if it's too low as there is on lowering it if it's too high - only the latter applies.

    The interest rate is not high, as it's only 1.25%... To say an interest rate of 1.25% would be over-appreciating the euro is probably untrue.
    If it were very high (say, 4 or 5%) then it would harm unemployment, but I think that the ECB has found a good balance between maintaining the price level and not affecting unemployment too much. If the price level becomes stable, but unemployment continues to be high, they have more leeway than England when it comes to reducing interest rates in order to control unemployment, but at the moment the UK are putting all their eggs in one basket (that of reducing unemployment), which instead continues to rise.

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  5. "but at the moment the UK are putting all their eggs in one basket (that of reducing unemployment), which instead continues to rise. "

    How do you know this?

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  6. We can see that unemployment is rising.. Or at least it has been over the last few months.

    And the fact that the government hasn't increased the interest rates suggests that they are trying still to stimulate growth and try to reduce unemployment rather than control the price level

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