The TWI is defined as system which defines the countrys exchange rate system in relation to the currencies of the

countries it trades with and is an indicator of its competitiveness. Many of the small economies open to global trade influences are changing them to TWI system as seen in NEW ZEALAND. It was adopted to summarise the position of the countrys exchange rate as the country is a small open economy and deals in transactions done in a range of different currencies thus faces many exchange rates .therefore a need for weighted average measure of individual bilateral exchange rates is there against the new Zealand dollar. But the small economies are ignoring the fact that TWI has certain errors which are discusses below. The trade weighted exchange rate system employs the goods only for determining the currency weights. The TWI system never distinctly takes the commodities trade while constructing the currency weights in spite of the fact that commodities trade have a global competition and not just a bilateral one. The TWI does not takes into account that a countrys manufactured product not only faces competition in the product market but also in among the manufactures market while dealing in foreign markets. The TWI is a general index thus it is unable to present the clear picture for instance the actual competiveness of the imports and exports of any country can be different from the general assumption. Another disadvantage of TWI is that it does not really measures all the trades being done in an economy as it only takes into consideration the list of the exchange of goods for payments being made by the companies and the government but few transactions are not really recorded which gives a wrong number for measuring the trades thus this procedure is a little unreliable. The TWI accuracy comes under question as the international cash flows have rapidly increases over the past few years because of the faster and easier information transmission and technological advances and this has enabled the investors to seize and investigate outside their so called determined and assumed zones. The TWI system also ignores the currency movement being done in the form of a currency of a country which is not a participant of the weighted index. Even omits some of the reserve assets which may be in the form of currencies and government securities.

http://imf.org/external/np/mfd/er/2006/eng/0706.htm

3a) When a country adopts a fixed rate of exchange for its currency, its authorities have limited control on the supply of money in the economy. This means that the authorities will have to buy its currencies when there is excess supply and sell when there is excess demand.(according to International Finance, by Keith Pilbeam, published in 1992 pg 119). Selling leads to a rise in the foreign reserves, whereas buying leads to a fall in the reserves. Let us consider the effects of a fixed exchange rate system when the supply of money increases due to purchase of government bonds by the central bank on an open market operation. In the diagram given below a monetary expansion causes a shift in the supply of money leading to an increase in the domestic supply, this difference can be measured by the difference in movement from the domestic base (D1,D2). This indicates a rise in the real value balance in the country. This eventually leads to an increase in domestic prices. To avoid such a devaluation in the currency, authorities have to purchase the domestic currency thereby exhausting its reserves (add). Thus an increase in the domestic base from D1 to D2 will lead to an equivalent fall in the reserves due to the intervention of foreign exchange reserves to maintain a fixed exchange rate.

Fixed exchange rate is known to have a constant exchange rate for a long period of time. Under this, authorities have limited control on the supply of money in the economy. This means that the authorities will have to buy its currencies when there is excess supply and sell when there is excess demand. Such an exchange rate system only permits reduced intervention, and if additional participation exists it would be counterproductive. Thus the central banks action can affect the domestic supply of money with interventions in the foreign exchange reserves while maintaining a fixed exchange rate system. When the fixed exchange rate system falls due to excessive purchasing on government bonds there is an increase in the domestic holdings of the residents of a country. This means that the government is trying to undergo budget deficits or raising finance through issue of bonds. The central bank purchases these bonds through the use of its foreign currency reserves, thereby leading to a decrease in these reserves. This also leads to increased supply of money and decrease in the domestic interest rates. However prolonged deficit financing through the issue of bonds would vastly deprive the economy of its reserves leading to adverse impacts towards its importers and exporters and would result in a breakdown in the fixed exchange rate system. A case study on the breakdown of the exchange rate system is seen in the collapse of the Mexican peso in 1982. Between 1977 and 1980 the exchange was a 23 Peso for 1 dollar, and in 1982 due to consistent deficit financing by Banco de Mexico; the Mexican Central Bank led to depleting foreign reserve and finally collapsed, within 30days of float the currency fell against dollars by 60%. It would also result in the big investors withdrawing their surpluses and investing in other countries in hope of expecting a higher return. Another reason for the fall in the fixed exchange rate system is the speculative depreciation which causes an increase in the demand for foreign currency along with and increase in the existing rate of inflation in the economy will experience a shift in the demand in favour of foreign goods to domestic; resulting in an overall fall in the foreign exchange reserves of the country.

3b)

4 a)
2000 Current account Goods and services Goods credit (FOB) debit (FOB) Services credit debit Income credit debit Current transfers credit debit -5.4 -3.3 -13.9 58.2 -72.1 10.6 26.2 -15.6 -3.6 2.1 -5.7 1.5 2.0 -0.5 2001 -5.2 -2.1 -12.4 53.9 -66.3 10.4 25.8 -15.4 -4.5 2.8 -7.3 1.4 1.8 -0.5 2002 -10.6 -7.0 -15.2 47.6 -62.8 8.1 23.1 -15.0 -4.4 2.8 -7.2 0.9 1.7 -0.8 % GDP 2003 -11.3 -7.4 -15.8 46.5 -62.3 8.4 22.5 -14.1 -5.3 2.6 -7.9 1.4 2.5 -1.1 2004 -11.3 -7.0 -16.2 49.2 -65.4 9.2 23.7 -14.5 -5.3 3.6 -8.9 1.0 3.5 -2.5 2005 -10.0 -6.4 -13.9 56.8 -70.6 7.5 23.4 -15.9 -4.1 5.3 -9.3 0.4 3.4 -2.9 2006 -15.5 -10.7 -17.4 58.8 -76.2 6.7 21.7 -15.0 -5.2 6.5 -11.7 0.4 3.2 -2.8 2007 -17.4 -11.4 -17.5 52.1 -69.6 6.1 20.4 -14.4 -6.8 7.8 -14.6 0.7 3.1 -2.4 2008 -9.8 -5.6 -13.2 53.1 -67.6 7.6 21.9 -14.2 -5.4 7.3 -12.6 1.2 3.3 -2.1

b)

Goods and services

20000 10000 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

-10000
-20000 -30000

Goods and services

We get the trade balance when we subtract the import from the export of the goods and services that the country imports or exports.

25 20 15 10 5 0

25 20 15 10 5 0

3b) def of PPP An increase or decrease in purchasing power of a currency resulting from a increase ore decreased in the domestic prices will lead to a measurable appreciation or depreciation of such currency. For example if a bottle of pepsi costs in india one INR and in the US one dollar. Keeping in mind the law on one price, there will be no trade barriers and assuming all other factors remaining equal the exchange rate will be the ratio of the prices to each other. Therefore INR1:$1 meaning that 1 INR will exchange for 1 dollar. If the price level in India increases by 20% and that same bottle of coke would sell for INR 1.20, thus giving us a new ratio of INR1.20:$1. therefore in a strict purchasing power parity system, when prices of goods and services increases in one country, the demand for such currencies and its product will fall relative to other currency, pushing back its exchange rate in line with the purchasing power of its currency in so far the reference basket of good used are the same, and thus the imbalance stroked out. 2a) Such a form of system provides stability by preventing fluctuations and speculative acts. It does not allow the exchange to fluctuate but rather to remain fixed against another currency. Fixed exchange rate system is introduced by the government when the economy is very unstable, when the currency is highly volatile due to hyperinflation. Estonia, Latvia were successful in implementing this regime to curtail their problems during this crisis of 2007-2010. by pegging the national currencies (generally small economies ) with those of advanced economies and have better future prospects in achieving higher economic stability(Schnabl,2003).

b) Pegged exchange rate to a currency basket. Some of the examples include Kuwaiti dinar, Singapore dollar and, Belarus(http://news.tut.by/economics/125555.html ). Pegging to a currency basket indicates that it gives the country an opportunity to diversify its risks because they generally have a few equally weighted trading partners. Most of the countries following the basket currency pegged rate take the advantage of economic growth and development of bigger countries.
c)

.Floating exchange rate within a predetermined band: Some examples of this are Iranian Real and Russia. In order to regulate its trading inefficiency, china also practices this regime in 2005. This rate is established when the floating rate has exceeded the benefits of the fixed rate. However at the same time the government would not like to lose its control over the situation. The currencies of these

countries are controlled within the narrow band major trade partner in order to enjoy stability in its exports as well as imports. Demand and supply