Chapter 4 Exchange-Rate Systems

1、Chapter 4 Exchange-Rate SystemsOutline of Chapter 4oForeign Exchange-Rate Practices oFixed exchange rate systemoFlexible exchange rate systemoHybrid exchange-rate systemClassifications of Exchange Rate Systems The IMFs classificationMore Flexible SystemsLimited Flexibility SystemsPegged systemsAn ec

2、onomists classificationFloating Exchange Rate SystemsFixed Exchange Rate SystemsExchange Rate Practiceso Floating rate - market determinedn Float independentlyn Float in unison with a group of other countriesn Adjust according to a formulao Fixed (“pegged”) raten Peg to a single major currencyn Peg

3、to a basket of currenciesn Peg to gold (obsolete)Exchange rate arrangements of IMF members, 2004Exchange ArrangementNumber of Exchange ArrangementExchange arrangements with no separate legal tender41Currency board arrangements7Conventional pegged (fixed) exchange rates41Pegged exchange rates within

4、horizontal bands5Crawling pegged exchange rates6Exchange rates within crawling bands1Managed floating exchange rates51Independently floating exchange rates35187Fixed Exchange RateoCentral banks pledge to maintain a preset level for the exchange rate by buying and selling currencies.Performance of Fi

5、xed Exchange Rateo Establish a par value against one or more key currencieso Create a stabilization fund to defend this fixed rateu However, at some point, because of basic economic changes, the fixed rate can become impossible to defend and must be changed.Fixed Exchange Ratesp Advantages of fixed

6、exchange rates- Less uncertainty- Stabilizing speculation- Price disciplinep Disadvantages of fixed exchange rates- High cost in balancing payments- Benefiting speculationExchange-Rate Stabilizationo Involve mechanisms to Correct Deficits or Surpluses in BOPoIllustration of a price adjustment Mechan

7、ismogovernment attempts to influence price levelsn Deficit requires decreasing money supply - reducing general price leveln Surplus requires increasing money supply - increasing general price levelChoice of Fixed Exchange Rateo Countries choosing fixed exchange rates tend to have:n relatively small

8、sizen relatively open economiesn harmonious inflation ratesn concentrated trade with a single partner countryFlexible Exchange RatesoUnder floating (Flexible) exchange rate systems, exchange rates are determined by forces of demand and supply.Performance of Flexible Exchange Rateo No par value!o No

9、limits on fluctuation of exchange rate!o No commitment to intervene in the forex market by central banks!o Market forces determine the level of exchange rate!o Balance of payment is the major factor in influencing the forex market.BOP Adjustment Mechanism nMovements in Exchange Rates correct BOP def

10、icits or surpluseso no need for external adjustment mechanismE.g. U.K in deficit against U.S= in excess supply = falls in value= British Export cheaper Import to Britain expensive= Deficit eliminatedp Advantages of flexible exchange rates- Market efficiency- Policy advantages p Disadvantages of flex

11、ible exchange rates- Great risk- Inflation- Destabilizing speculationFlexible Exchange RatesHybrid Exchange Rateso It combines various features of fixed and floating exchange rate in different degrees.o Fluctuation bands differs among adjustable pegged-rate system crawling pegs managed floatingAdjus

12、table Pegged Rateso In a pegged exchange rate system, the home currencys value is pegged to a foreign currency or to some unit of account, and moves in line with that currency or unit against other currencies.Adjustable Pegged Exchange Rateso In a managed (or “dirty”) exchange rate system, exchange

13、rates are allowed to move freely on a daily basis and no official boundaries exist. However, governments may intervene to prevent the rates from moving too much in a certain direction.o Cons: A government may manipulate its exchange rates such that its own country benefits at the expense of others.o

14、 Partially Flexible Exchange RatenThe government sometimes affects the exchange rate and sometimes leaves it to the market.Managed Floating RatesManaged Floating Rates in the Short Run and Long RunExchange rate stabilization and monetary policyCrawling Pego A system of exchange rate adjustment in wh

15、ich a currency with a fixed exchange rate is allowed to fluctuate within a band of rates. The par value of the stated currency is also adjusted frequently due to market factors such as inflation. This gradual shift of the currencys par value is done as an alternative to a sudden and significant deva

16、luation of the currency. Crawling Pego The exchange rate is constrained within a narrow band, but the band is allowed to move slowly over time (e.g., Mexico, Brazil, and Russia in the 1990s, before they floated). - However, the crawl tends to be too slow. So the currency becomes overvalued, resultin

17、g in exchange-rate crises and big devaluations (just as under adjustable peg rates).- Establishing a fixed exchange rate is difficult in an economy with high inflation- Frequent changes keep pegged rates from becoming unrealistic, and unannounced changes keep speculators at bay.Currency Boardso A cu

18、rrency board is a monetary authority empowered to issue domestic currency which can be converted at a fixed exchange rateo The rate is usually set in law, and the board must have foreign exchange reserves large enough to cover the domestic currency in circulationo Put another way, the domestic money

19、 supply is limited by the amount of foreign reserves on hando Currency boards do not make loans or finance government deficitso Currency boards have become popular as a solution for countries which have not been able to control inflation or hold to a fixed exchange rateo The boards guarantee stabili

20、ty of exchange rate o But the boards also leave no flexibility in monetary policy to respond to changing circumstances and require large foreign exchange reserves; experience has been mixedCurrency BoardsDollarizationo Dollarization refers to the replacement of a local currency with U.S. dollars or