The Net Exports Effect is the initial impact on a country’s spending caused by a universe relationship between price level and the net exports of an economy.
Change of balance of payment during economic expansion
The balance of payment can be defined as the accounting of all monetary transactions between a given country and the rest of the world. The transactions involve the payment of the country’s import and export of the financial transfers, financial capital, services and goods. It sums up all the transactions for particular period of time and is usually prepared with one country (Treasury Staffers, 2011).
When the transactions and all the components of the Balance of payment are included, it should add to zero without the error of surplus or deficit. For instance, if country A imports more goods or services than when it can export, its trade balance swill then be deficit, but the outcome shortfall will have to be counterbalanced in another ways like funds earned as a result of foreign investment, or by borrowing loans from other countries (Treasury Staffers, 2011).
Under the system of fixed exchange rate, the central bank is responsible for taking flows either by providing foreign exchange currency to the foreign exchange market or the purchase of the inflow of the funds into the country. Alternatively, managed float may be used where the exchange rates are allowed. In such system, the central bank will not intervene with the value the currency (Treasury Staffers, 2011).
Change of the rate of interest during economic expansion
As the fed raises or lowers sort-term interest rates, bank may either lower or increases the exchange rate it change the prospective consumers. It affects the following:
The consumer: Bank usually set the prime rate for the consumer loan and the credit card. If a consumer is granted with the adjustable rate mortgage, or the credit card which is linked to the prime rate, then the payments will have to rise or fall according to the prime rate (Sullivan, Arthur; Steven M. Sheffrin, 2003)
The entire economy: The change in the rate of interest may change the overall economy. For instance, while the decrease rates may enable business people to finance expansion and other financial activities, increase of interest on the other hand will make fewer consumers taking auto loans, which may in the result cause the slowdown in the automobile industry.
The value of dollar
The value of dollar has been decreasing simultaneously since 2002. The weakening of a dollar may be a sign of diminishing stand in the global economy, rising public debt, and weak economy recovery.
Flexible exchange rate and a fixed exchange rate
Under the fixed exchange rate system, the central bank is responsible for accommodation of the flows by buying up any net inflow of fund into the country or through providing foreign exchange funds thus ensuring that funds from exchange rate from country’s currency in relation to the other countries is stopped. In flexible rates, the changes of exchange rate are usually allowed or the other extreme. The central bank does not intervene or devalue its currency hence rate to be set by the market (Kenen, 2000)
Reference
Kenen, P. (2000) Fixed versus floating exchange rate. Cato Journal, Vol. 20, No. 1.
Treasury Staffers: Report to Congress on International Economic and Exchange Rate Policies (2011). Retrieved on August, 17, 2011 from United states Department of Treasury.
Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 310.