Vocabulary Notes to Text 9.7.1.2

1. a basket of goods and services — корзина товаров и услуг

2. the purchasing-power parity — паритет покупательной способности

3. market exchange rates — рыночные валютные курсы

4. a preferred alternative — предпочтительная альтернатива

9.7.1.З. Read the text “The Exchange Rate as a Component of the Price Mechanism between the

Domestic and International Consumption Sectors.” Give a synopsis of it either in English or in Russian.

The Exchange Rate as a Component o f the Price Mechanism between the Domestic

and International Consumption Sectors

Transactions in foreign exchange occur spot or forward (spot market and forward market) in the

foreign-exchange markets. The actual rate at any one time is determined by supply and demand

conditions for the relevant currencies in the market. However, probably the best way of viewing the

exchange rate is as the economy’s device for altering the relative prices of domestic produce, which

does not trade internationally; and international produce, subject to import and export.

Take an example. Oil is priced internationally, with prices set in dollars. Competitive forces

ensure the UK price of oil is the same as the global price. Haircuts, on the other hand, cannot be

Imported and are priced locally. If the pound devalues, the price of oil remains constant in dollar

terms, so automatically rises in pound terms. The price of haircuts remains constant in pound

terms, so the relative price of haircuts has fallen. Hairdressing will now be relatively less profitable

compared to oil production. The signal sent by the exchange rate eases adjustments in the economy

between the domestic and international sectors. Often when the economy receives a “shock,”

the relative size and profitability of the two sectors has to adjust, and the exchange rate is one

means by which the price changes needed to induce the adjustment can be transmitted to the two

sectors. For instance, a shock might include a big rise in domestic savings, without a rise in domestic

Investment. In this event, consumption at home falls, and exports logically need to rise to offset

this. The exchange rate falls, increasing demand for exports through lower prices. The exchange

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rate is simply a component of the price mechanism, albeit an important one, responding to the

pressures set by preferences for domestic and foreign goods, and the flows of savings and investment

funds across currencies. It follows that the value of the currency is obviously also determined

by domestic monetary policy — more inflation tends to mean a lower exchange rate as, without a

depreciation, inflation hits the tradable sector more harshly than the non-tradable. (The tradable

sector gets squeezed, as it has to hold its prices constant in world markets, while the domestic

sector can raise its local prices in an inflationary environment more easily.) Representing such an

Important economic variable, governments have often sought to control exchange rates. It may be

seen as the most effective means of stabilizing monetary policy, especially in smaller countries.