Download Exchange Rate Regimes

EXCHANGE RATE REGIMES
Julie Harris
Fixed vs. Floating
Fixed


The exchange rate
fluctuates in a narrow
range (or not at all)
against a base currency
over a sustained period
of time.
Government action is
needed to maintain the
exchange rate.
Floating



The exchange rate
fluctuates in a wider
range.
No government
intervention to fix the
exchange rate against a
base currency.
Appreciation/Depreciation
can occur frequently.
Fixed
0.19
Euros per Danish Krone
0.17
0.16
0.15
0.14
0.13
0.11
0.1
1.6000
1999-01-01
1999-08-01
2000-03-01
2000-10-01
2001-05-01
2001-12-01
2002-07-01
2003-02-01
2003-09-01
2004-04-01
2004-11-01
2005-06-01
2006-01-01
2006-08-01
2007-03-01
2007-10-01
2008-05-01
2008-12-01
2009-07-01
2010-02-01
0.2
1999-01-01
1999-07-01
2000-01-01
2000-07-01
2001-01-01
2001-07-01
2002-01-01
2002-07-01
2003-01-01
2003-07-01
2004-01-01
2004-07-01
2005-01-01
2005-07-01
2006-01-01
2006-07-01
2007-01-01
2007-07-01
2008-01-01
2008-07-01
2009-01-01
2009-07-01
2010-01-01
Fixed vs. Floating
Floating
U.S. Dollar per Euro
1.5000
0.18
1.4000
1.3000
1.2000
1.1000
0.12
1.0000
0.9000
0.8000
Increasingly Fixed
No Separate Legal Tender
No Separate Legal
Tender (41)

The currency of another country circulates as
the sole legal tender. E.g. Ecuador uses the U.S.
Dollar – known as “dollarization”
 The country belongs to a monetary or currency
union in which the same legal tender is shared
by the members of the union. E.g. Members of
the European Union
Currency Boards (7)

Other fixed Pegs (52)
Pegged within
horizontal bands (6)
Increasingly Floating
Crawling peg (5)
Managed floating with
no pre-determined
path for the exchange
rate (51)
Independently Floating
(25)
Exchange agreements with no separate
legal tender come in two forms:

These regimes result in a complete
surrender of the monetary authorities’
independent control over domestic
monetary policy.
Increasingly Fixed
Currency Boards
No Separate Legal
Tender (41)
Currency Boards (7)
Other fixed Pegs (52)
Pegged within
horizontal bands (6)
Crawling peg (5)
Increasingly Floating

Managed floating with
no pre-determined
path for the exchange
rate (51)
Independently Floating
(25)


Currency Boards are monetary regimes based on an
explicit legislative commitment to exchange domestic
currency for a specified foreign currency at a fixed
exchange rate, combined with restrictions on the
issuing authority to ensure the fulfillment of its legal
obligation. E.g. Hong Kong fixes its exchange rate
with the U.S.
Domestic currency is issued only against foreign
exchange and remains fully backed by foreign assets.
Eliminates traditional central bank functions such as
monetary control and lender-of-last-resort. There is
very little room for discretionary monetary policy
(depends on the strictness of the banking rules in
place).
Increasingly Fixed
Other Fixed Pegs
No Separate Legal
Tender (41)

The country pegs its currency, at a fixed rate, to another
currency or a basket of currencies.

Currency Boards (7)
Other fixed Pegs (52)
Pegged within
horizontal bands (6)

There is no explicit legislative commitment to keeping the
arrangement.

Increasingly Floating
Crawling peg (5)
Managed floating with
no pre-determined
path for the exchange
rate (51)
Independently Floating
(25)
The basket is formed from the currencies of major
trading/financial partners and weights reflect the
geographical distribution of trade, services, or capital flows.

The exchange rate can fluctuate within a narrow range.
The monetary authority attempts to maintain the fixed rate.



Directly: sale/purchase of foreign currencies
Indirectly: interest rate policy, foreign exchange regulations, etc.
Traditional central banking functions are still possible and the
monetary authority can adjust the level of the exchange rate
(relatively infrequently).
Increasingly Fixed
Pegged within Horizontal Bands
No Separate Legal
Tender (41)

Currency Boards (7)
Other fixed Pegs (52)
Pegged within
horizontal bands (6)

Increasingly Floating
Crawling peg (5)
Managed floating with
no pre-determined
path for the exchange
rate (51)
Independently Floating
(25)

Similar to fixed peg systems – currency is
maintained within a small margin (bands)
around a fixed central rate.
One key difference: also includes
arrangements of countries in the exchange
rate mechanism of the European Monetary
System. E.g. Denmark
There is a limited degree of monetary
policy discretion – the amount depends on
the band width.
Increasingly Fixed
Crawling Pegs
No Separate Legal
Tender (41)
Currency Boards (7)
Other fixed Pegs (52)
Pegged within
horizontal bands (6)
Crawling peg (5)
Increasingly Floating



Managed floating with
no pre-determined
path for the exchange
rate (51)
Independently Floating
(25)
Currency is adjusted periodically in small
amounts at a fixed rate or in response to
changes in selective quantitative indicators i.e.
the exchange rate is allowed to follow a trend.
E.g. Columbia
The rate of the crawl can be set to:


generate inflation-adjusted changes in the
exchange rate (backward looking)
a preannounced fixed rate and/or below the
projected inflation differentials (forward looking)
Constraints on monetary policy are similar to a
fixed peg system.
Increasingly Fixed
Managed Floating with No Pre-Determined
Path for the Exchange Rate
No Separate Legal
Tender (41)

Currency Boards (7)
Other fixed Pegs (52)
Pegged within
horizontal bands (6)

Increasingly Floating
Crawling peg (5)
Managed floating with
no pre-determined
path for the exchange
rate (51)
Independently Floating
(25)

Monetary Authority attempts to influence
the exchange rate without having a specific
exchange rate path or target. E.g.
Afghanistan
Often used to prevent drastic depreciation
of the currency (exchange rate crisis) –
more common in developing countries.
Indicators for managing the rate are
broadly judgmental. E.g. Balance of
payments position, international reserves,
etc.
Increasingly Fixed
Independently Floating
No Separate Legal
Tender (41)
Currency Boards (7)
Other fixed Pegs (52)
Pegged within
horizontal bands (6)
Crawling peg (5)
Increasingly Floating

Managed floating with
no pre-determined
path for the exchange
rate (51)
Independently Floating
(25)

The exchange rate is marketdetermined. E.g. U.S.
Any official foreign exchange market
intervention is aimed at moderating the
rate of change and preventing undue
fluctuations in the exchange rate (as
opposed to establishing a level for the
exchange rate).
Developing Countries
Developing vs. Developed


Currencies of developing
countries tend to be more
volatile – they face
exchange rate crisis more
often.
Most of the floating systems
are from developed
countries (with the exception
of the EU).
Exchange Rate Crisis - Example
30000
25000
20000
15000
10000
5000
0
Ecuadorean Sucres per U.S. Dollar