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Opportunity Cost


1.      Introduction

Opportunity cost is a decision under limited resources to have more of something but simultaneously have less of something else (Kidane, 2002).  It can be used to evaluate the possible trade-offs of a decision like HK pegging its dollar to US dollar.

2.      Discussion

For HK pegging its dollar to US dollar, the major opportunity cost is that there is little scope for the use of monetary policy for domestic stabilization purposes because the sensitivity of international capital flows to interest rates.  The HKSAR is forced to maintain domestic interest rates close to the levels existing in the US and it is not able to bring about substantial changes in the domestic money supply.  The other key aspects of policy including fiscal policy must also be kept consistent with the peg, for example strict fiscal discipline to remain balanced budgets is required to stabilize the peg system.  Borrowing through the bond market is not possible as this may affect interest rates and put pressure on the pegged exchange rate (Caramazza and Aziz, 1998).  The availability of adequate amounts of reserve is a must to offset imbalances in demand and supply by government sales and purchases of foreign exchange (Jackson et al, 1999).  However, the reserve can solve short-term fluctuations only (like 1998 intervention); it cannot do this indefinitely as sooner or later the reserve will be exhausted.  The other opportunity cost is that the peg is extremely sensitive to domestic political developments or external shocks that affect investor¡¦s expectations.  There are increasing numbers of people begin to doubt the HKSAR¡¦s ability to maintain the current exchange rate and believe that a realignment of rates is due.  This increases risk from attracting speculators attack on the peg system especially the economy of HK is not functioning successfully like deflation, reduced GDP, high unemployment rate, and diminishing competitiveness due to currency devaluation of its neighbor countries after the Asian economic crisis and the catching up of China.

3.      Conclusion

Opportunity cost is a consideration of the possible trade-offs of a decision.  So it is required considering the alternative course of actions carefully before a decision is made.  For example, trade-offs must exist between fixed and floating exchange rates and hence, there is no single exchange rate regime that is suitable to all economies.


References

Caramazza, Francesco and Aziz, Jahangir (1998), ¡¥Fixed or Flexible: Getting the Exchange Rate Right in the 1990s¡¦, International Monetary Fund, April, [Online, accessed 8 January 2002]
URL: http://www.imf.org/external/pubs/ft/issues13/

Jackson, John; McIver, Ron; McConnell, Campbell and Brue, Stanley (1999), Economics, 5th Edition, McGraw-Hill, Sydney NSW

Kidane, Hailu (2002), Business Economics, Charles Sturt University


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