Starting from 1997, Lebanon’s exchange rate was fixed at 1,500 Lebanese pounds to the dollars. However, due to the shortage of dollars, depreciation has occurred and led to 1600 Lebanese pounds per dollar. Due to the shortage of dollars, Lebanese pounds have been depreciated. Therefore, in order to maintain fixed currency, Lebanon’s central bank has to use policies to control the demand and supply of the currency.
Looking at Lebanon’s economic situation, due to the shortage of Dollars, the demand for dollars has risen leading the Supply curve to shift to the left leading Lebanese pound to increase from 1500 to 1600 per dollar. Therefore in order to maintain fixed currency, the central bank of Lebanon has to decrease the demand for dollars. Therefore, the central bank may buy Lebanese pounds by selling reserves of foreign exchange. Therefore, demand for dollars will decrease. Or, the central bank can increase the interest rate for their country. By this behavior, the foreign investors will exchange their money to FOREX and save Lebanese pounds which will also decrease the demand for dollars. Hence, shifting the demand for $ to the left leading the currency from B to C. Thus, maintaining fixed currency for the country Lebanon.
However, there are some disadvantage of using these policies. If central bank keeps on selling foreign reserves, the country will run out of reserves to sell. Therefore, the country will run out of dollars and may experience IMF like South Korea in 1997 due to the shortage of dollars. Furthermore, if Lebanon continues to maintain high interest rate, it will cause the nation to fall into recession. Because people will save more, consumption will decrease. By this behavior, firms will decrease their investment and will lead the economy to deflationary spiral.
Even though, there might be some disadvantages of using these policies, maintaining fixed currency gives huge advantages to the country. By having fixed currency, it provides currency stability. Hence, showing that the currency from that nation is worthy enough to the foreign investors. Thus, by having fixed currency, the country can avoid inflation when other strong nations like United States currency grows. As foreign currency grows while Lebanon maintain fixed currency, domestic firms will can grow their business because cost of import goods will be expensive than the domestic goods. Therefore, leading Lebanon to stay away from danger when currency speculations happens.
On the other hand, maintaining fixed currency are expensive. In the article, it says that Lebanon has $38.5 billion foreign reserves and their foreign reserve have increased 4 times than 2005. However, in order to decrease the demand for dollars, the central bank may have to sell their foreign reserves. But, to maintain their fixed currency, they have to keep converting its foreign exchanges to maintain their currency. Therefore, this may be Lebanon’s potential threats that can disrupt them from maintaining fixed currency.
Due to the economic decision, it may bring benefits and potential threats to the nations. However, Lebanon has steadily increased their foreign reserves to maintain their currency. Therefore, by selling foreign reserves can surely cover the cost for pulling out Lebanon from devaluation . Even though it might be the potential threat of disrupting fixed currency, by using these policies, it will bring currency stability and protect domestic producers which outweighs the disadvantages.