Macroeconomic Issues and their Implications for Exposure

Abstract

We have now applied the concepts from Part II, on economic exposure,to a discussion of EMU and how operating exposure will change. The driving force for operating exposure change is the likelihood that relevant (real) exchange rates will become much more predictable in most industries. There is less exchange rate risk. You should not put the book down, however, without reading the present chapter. Remember that economists are pretty much nonplussed as to what drives exchange rates in the short to medium run. This point should not be taken too far though — we know that ultimately exchange rates are driven by fundamentals (as indeed are other asset prices such as stock prices). We also know that when a country is hit by adverse shocks it can ease the adjustment process by having access to an independent monetary policy and the exchange rate instrument. Given that prices and wages tend to be sticky, expansionary monetary policy can increase the level of activity in the domestic economy if a country is faced with a recession. Similarly, monetary policy can be used to cool down an overheating economy. The issue of to what extent that monetary policy can affect any real variables is not entirely resolved, but it is fair to say that the common wisdom amongst economists is that monetary policy can substantially affect the real economy in the short to medium run. Going very deep into the reasons for price and wage stickiness would take the book too far afield.