Question

I'd the government fixes our (papua new guimea) exchange rate at 1 dollar what would be the effect on export and balance of payment

Answer 1

If the Papua New Guinea (PNG) government were to fix the exchange rate at 1 dollar (presumably referring to the PNG Kina being fixed to the US dollar), there would be several potential effects on exports and the balance of payments.

### Effects on Exports

1. **Competitiveness**: If the fixed exchange rate is set at a level that is higher than the market equilibrium, PNG exports may become less competitive on the global market. This is because foreign buyers would find PNG goods more expensive compared to those from countries with lower exchange rates. For example, if the exchange rate is set unfavorably against the USD or other currencies, exporters may struggle to sell their goods internationally.

2. **Market Distortion**: Fixing the exchange rate can lead to distortions in the market. If exporters feel that the fixed rate does not reflect the real value of the Kina, they may reduce production or seek other markets where they can get better prices, ultimately leading to a decrease in export levels.

3. **Income Effects**: If exporters receive less local currency for their goods due to the fixed exchange rate, their income may decrease. This can lead to reduced investment in expansion or new projects, impacting long-term export capabilities.

### Effects on Balance of Payments

1. **Trade Balance**: A fixed rate may negatively impact the trade balance if exports decrease. If imports remain unchanged or increase (as consumers find imports cheaper compared to local goods), this could lead to a deterioration of the trade balance.

2. **Capital Inflows/Outflows**: A fixed exchange rate may attract short-term capital inflows (if the rate is seen as stable), but could also lead to capital outflows if investors believe that the fixed rate does not reflect the true market value of the currency. These capital movements can heavily influence the overall balance of payments.

3. **Currency Reserves**: To maintain a fixed exchange rate, the government will need to intervene in the currency market, requiring substantial foreign exchange reserves. If these reserves deplete (due to a high trade deficit, for instance), the government might face difficulties in maintaining the peg, leading to potential economic instability.

4. **Inflation**: If fixing the exchange rate leads to inflation in the country, the purchasing power may decline. This can further impact imports (if they become more expensive) and exports (if domestic goods can't compete internationally).

In summary, a fixed exchange rate has significant implications for both exports and the overall balance of payments for Papua New Guinea. It can create benefits in terms of stability but also impose challenges such as dependent competitiveness and potential economic imbalances. The actual outcomes would depend on the specific rate set, the current economic environment, and the government's overall policies.