Over-valued currency (or artificially appreciated value) is equivalent to the value of this currency below the market settlement value. This is partly due to the inability of the central bank to set the exchange rate for market settlements. Therefore, excessive demand for foreign currency will arise (P. Samarasiri 2010, p. 5). Currency over-valuation is common in East Asian economies because of, for example, speculative capital inflows and or government inflation stabilization policies (H. M. Hsing 2004, p 123).
Over-valued currency (under-valued currency exchange) can be caused by long-term constant exchange rates due to significantly higher inflation rates compared to developing countries from which imports are sourced (Ö. H. Birol 2012, p. 93).
Initiatory benefit of an over-valued currency
The first experience of an over-valued currency may seem beneficial to the citizens of the poorer country. The surplus period follows. Imports seem cheap, so citizens are in a hurry to buy new goods and services from richer countries, which can greatly benefit the sale of cars and military equipment to the government, companies, and individuals. Banks can borrow huge amounts of money at low rates, which leads to sudden wealth enrichment. This is a time of euphoria (A. Pettifor 2015, p. 13).
The negative effects on an over-valuated currency
An over-valued currency can lead to:
- Unemployment (provided that at the same time a loss of international competitiveness occurs)
- Inflation (which leads to higher import prices) (C. Alexiou, J. Nellis 2012, p. 297).
- Lower production growth compared to the under-valued real exchange rate (J. L. Oreiro, F. Missio, F. G. Jr. Jayme 2015, p. 250).
In the early 1980s, wages were falsely raised in the hope that companies would be motivated to look for ways to enhance efficiency. During this period, Singapore had an inflated exchange rate because the Singapore dollar was closely linked to the over-valued price of the US currency. The over-valued currency is favorable to the marketable sector and unfavorable to the non-marketable sectors. The negative impact of the over-valued currency on exports of services such as tourism and medical care was very apparent after the Asian currency crisis of 1997 and 1998. During this time, coastal tourism from East and Southeast Asian countries decreased significantly and even almost disappeared. Private hospitals and clinics in Singapore were also damaged (H. H. A. Tan 2014, p. 1).
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- Oreiro J. L., Missio F., Jayme F. G. Jr., (2015), Capital Accumulation, Structural Change and Real Exchange Rate in a Keynesian-Structuralist Growth Model, "Panoeconomicus", Volume 62, Issue 2
- Pettifor A., (2015), Why the euro is the gold standard writ large – and like the gold standard, will fail, "Prime"
- Samarasiri P., (2010), How do central banks manage exchange rates?, Central Bank of Sri Lanka
- Tan H. H. A., (2014), Singapore’s competitiveness at risk, "Research Collection School Of Economics"
Author: Katarzyna Satro