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Fixed Exchange Rate & Foreign
Exchange Intervention
Fixed exchange rate: end of World War II-1973
Hybrid system (managed floating): after 1973
feature: central banks routinely intervening
Chinese version
Fixed exchange rates?
1. Managed floating
2. Regional currency arrangements
3. Developing countries and countries in
transition
4. Lessons of the past for the future
Central bank intervention
& the money supply
• central bank transactions in asset markets
• the central bank balance sheet
• according to the principles of double-entry
bookkeeping
double-entry bookkeeping
Assets
Liabilities
Any acquisition of an asset Any increase in the bank’s
by the central bank (a
liabilities (a positive change)
positive change)
increase +
reduce –
+
–
Changes in the central bank’s
assets cause changes in the
domestic money supply
• When the central bank buys an asset from the
public, its payment (cash/check) enters the
money supply.
• the asset purchase →money supply to
expand.
• the asset sale →receive cash or check
→money supply shrinks
upshot
• Changes in the level of central bank asset
holdings cause the money supply to change in
the same direction because they require
equal changes in the central bank’s liabilities.
• Any central bank purchase of assets
automatically results in an increase in the
domestic money supply, while any central
bank sale of assets automatically causes
the money supply to decline.
Money multiplier Effect
• When the central bank buys assets, the
accompanying increase in the money supply
is larger than the initial asset purchase
because of multiple deposit
creation within the private banking
system.
Central Bank Balance Sheet
Assets
Liabilities
Foreign assets $1000 Deposits held by
private banks
$500
Domestic assets
Currency in
$1500 circulation
$2000
$2500
$2500
Exchange intervention
Assets
Liabilities
Foreign assets $1000 Deposits held by
private banks
$500
① sell $100 for ￥
Domestic assets
Currency in
$1500 circulation
$2000
② pay $100 in ￥
$2500
$2500
Decline in Money Supply
Assets
Liabilities
Foreign assets $900
Deposits held by
private banks
$500
Domestic assets
Currency in
$1500 circulation
$1900
$2400
$2400
private citizen’s action
Assets
Liabilities
Foreign assets $900
Deposits held by
private banks
$500
②Private bank deposits with the
Domestic assets
central bank fall by $100
Currency in
$1500 circulation
$1900
① buyer of foreign asset pays
a $100 check drawn on deposit
$2400
$2400
result of such action
Assets
Liabilities
Foreign assets $900
Deposits held by
private banks
$400
Domestic assets
Currency in
$1500 circulation
$2000
$2400
$2400
Sterilization
• Sterilized foreign exchange intervention:
Central banks carry out equal foreign
and domestic asset transactions
in opposite directions to nullify the
impact of their foreign exchange operation on
domestic money supply.
Before Sterilized $ 100 Sale
Assets
Liabilities
Foreign assets $1000 Deposits held by
private banks
$500
① sell $100
Domestic assets
Currency in
$2000
$1500 circulation
减少check $100→
货币供应量减少
$2500
$2500
Sterilized Process
Assets
Liabilities
Foreign assets $900 Deposits held by
private banks
$500
① sell $100
Domestic assets
Currency in
$2000
$1600 circulation
增加check $100→
②buy $100 of domestic A
货币供应量增加
$2500
$2500
After Sterilized $ 100 Sale
Assets
Liabilities
Foreign assets $900 Deposits held by
private banks
$500
Domestic assets
Currency in
$1600 circulation
$2000
$2500
$2500
Table 17-2 Summary 简译
本国央行的
行为
对本国货币
供给的影响
对央行本国
资产的影响
对央行外国
资产的影响
不冲销的外
汇购买
+$100
0
+$100
冲销的外汇
购买
0
-$100
+$100
不冲销的外
汇购买
-$100
0
-$100
冲销的外汇
购买
0
+$100
-$100
Balance of Payments & Money Supply
• Different definition:
• BOP is the sum of the current account
and the non-reserve component of
capital account, that is, the international
payment gap that central banks must finance
through their reserve transaction.
BOP & Growth of Money Supply
• If central banks are not sterilizing and the home
country has balance of payments surplus, any
associated increase in the home
central bank’s foreign assets implies
an increased home money supply.
Similarly, any associated decrease in a foreign
central bank’s claims on the home country
implies a decreased foreign money supply.
Burden of BOP adjustment
1. Macroeconomic goals of the central banks and
institutional arrangement governing intervention;
2. Central banks may be sterilizing to counter
the monetary effects of reserve changes;
3. Some central bank transactions indirectly
help to finance a foreign country’s BOP deficit.
How the central bank fixes the
exchange rate?
Through foreign exchange intervention.
Condition: only if its financial transactions
ensure the asset market remain in
equilibrium when the exchange rate is at its
fixed level.
1. Foreign exchange market
equilibrium
2. Money market equilibrium
•
•
Exchange market equilibrium
• Interest rate parity must hold
R  R * ( E  E ) / E
R  R*
e
Expectation of
domestic
currency is zero!
Money market equilibrium
M / P  L( R, Y ) R  R *
s
M / P  L( R*, Y )
s
R* equates aggregate real domestic money demand and real money
supply.
Given P and Y, the above equilibrium condition tells what the
money supply must be if a permanently fixed exchange rate is
consistent with asset market equilibrium at foreign exchange rate of
R*.
• A rise in output raises the demand for
domestic money…
• This foreign asset purchase (by the central
bank) eliminates the excess demand for
domestic money because the central bank
issues money to pay for the foreign assets it
buys.
EE
R  R*
0
E
0
维持固定汇率 E
●
外币储蓄的本币收益
R * ( E 0  E ) / E
●
1
L( R, Y )
R
L( R, Y 2 )
②货币供应增加
M1
P
M2
P
实际国内货币持有
●
●
●
①产出增加
实际货币供给
Stabilization Policies
Alternatives:
1. Monetary policy
2. Fiscal policy
3. An abrupt change in the exchange rate’s
fixed level, E0
Two alternatives under the fixed
• By fixing the exchange rate, the central
bank gives up its ability to influence the
economy through monetary policy. Fiscal
policy becomes a more potent
tool for affecting output and employment.
Analysis approaches
• DD-AA model
• Add the assumption that the expected future
exchange rate (Ee) equals the rate E0 at
which the central bank is pegging.
1. Monetary Policy
• Under a fixed exchange rate, central bank
monetary policy tools are
powerless to affect the economy’s
money supply or its output.
在固定汇率制下货币扩张是无效的
E
DD
央行不得不出
售外国资产来 2
E
换回本币
②
维持固定汇率 E0
①
AA2
中央银行通过购
买国内资产扩大
国内货币供给来
增加产出
AA1
Y1
Y2
Y
2. Fiscal Policy
• Fiscal policy can be used to affect
output under a fixed exchange rate.
• In comparison with under a floating rate,
fiscal expansion is accompanied by an
appreciation of domestic currency and the
central bank is forced to expand the money
supply through foreign exchange purchases.
为了避免过度的
货币需求造成利 E
率上升,引起本币
升值,央行购买外
国资产,从而增加
了本币的供给,这
种干预移动了AA
曲线
0
财政扩张政策移动DD
DD1
DD2
③
①
E
②
本币升值压力
E2
AA2
AA1
干预结果产出增加而汇率不变
Y1
Y2
Y3
Y
3. Changes in the exchange rate
• Devaluation (or revaluation) is a last
resort for the central bank…
• Devaluation causes a rise in output, a rise
in official reserves, and an expansion of the
money supply. A private capital inflow
matches the central bank’s reserve gain (an
official outflow) in the balance of
payments account.
E
DD
E1
E0
②
本币贬值
①
Both output &
money supply
expand
AA2
AA1
Y1
Y2
Y
Why choose to devaluate?
1. Devaluation allows the government to fight
domestic unemployment despite the
lack of effective monetary policy.
2. Devaluation is the most convenient way of
boosting aggregate demand.
(government spending and budget deficit
unpopular)
3. Central bank is running low on reserves,
devaluation is a kind of tax on holders of
government bonds and money.
Balance of payments crises &
capital flight
• The market’s belief in an impending
change in the exchange rate gives rise to
a balance of payments crisis, a
sharp change in official foreign exchange
reserves sparked by a change in
expectations about the future exchange rate.
E
本币贬值预期右移
外币储蓄的本币收
E0
益曲线
⑴
●
⑵
外币储蓄的本币收益
●
R * ( E1  E ) / E
R * ( E 0  E ) / E
央行必须出售外汇储
备,紧缩国内货币供 2
M
给。
R
0
0
R
L ( R, Y )
●
②
P
M1
P
R * ( E  E ) / E
1
●
①
实际国内货币持有
实际货币供给
Upshot
• The expectation of a future
devaluation causes a balance of
payment crisis marked by a sharp fall
in reserves and a rise in the
home interest rate above the world
interest rate and vice versa.
Capital flight
• The reserve loss accompanying a
devaluation scare is often labeled capital
flight because the associated debt in the
balance of payments accounts is a private
capital outflow.
What causes currency crises?
• Central bank is compelled to buy bonds
form the domestic government to allow the
government to run continuing fiscal deficits.
• Central bank’s purchases of domestic assets
cause losses of foreign exchange reserves.
• Central bank can not support of rise of
domestic interest rate.
Solution to the currency crises
• The central bank should stop bankrolling
the government deficit, hopefully forcing
the government to live within its means.
• Independence of central bank.
Self-fulfilling currency
crises
• An economy can be vulnerable to
currency speculation without being
in such bad shape that a collapse of its fixed
exchange regime is inevitable.
• An economy in which domestic commercial
banks’ liabilities are mainly shortterm deposits. The central bank has to
lend money to the commercial banks.
Managed floating & sterilized
intervention
• Under managed floating, monetary policy is
influenced by exchange rate changes without
being completely subordinate to the
requirements of a fixed rate.
• The central bank faces a trade-off
between domestic objectives
(employment or the inflation rate) and exchange
rate stability.
• Such efforts are usually ended in
sterilization or nullification.
Intervention=sterilization?
• Tools of intervention: money supply &
interest rate.
• Empirical studies confirm that such
intervention are sterilized throughout the
20th century and earlier.
Perfect asset substitutability &
Ineffectiveness of sterilized
intervention
• Without change in the domestic money
supply, any intervention by the central bank
will not affect the domestic interest rate
and therefore will not affect the exchange
rate.
Mexico’s 1994 Balance of Payments Crisis
利率被迫拉升
储备不断减少
Sterilization is fruitless under the
fixed exchange rate
• The ineffectiveness of monetary policy under a
fixed exchange rate implies that sterilization is
a self-defeating policy.
Perfect asset substitutability
• All interest-bearing (non-money) assets denominated in
the same currency, whether illiquid time deposits or
government bonds, are perfect substitutes in
portfolios.The single term “bonds” will generally be
used to refer to all assets.
• Interest Parity Condition holds
• Nothing a central bank can do through intervention.
Imperfect asset substitutability
• Risk in the foreign exchange market.
• Risk preference is different to
investors.
• Perfect asset substitutability: expected rate
of return that matters
• Imperfect asset substitutability: both
returns and risk that matters.
Exchange market equilibrium under
imperfect asset substitutability
• Comparison:
• Perfect asset substitutability: 利率平价论成立
R  R * ( E e  E ) / E
• Imperfect asset substitutability:附加风险贴水
本国政府债务存量
   ( B  A)
R  R * ( E e  E ) / E  
中央银行的本国资产
Skip over page 508-510
• With imperfect asset substitutability, even
sterilized purchases of foreign
exchange cause the home currency to
depreciate. Similarly, sterilized sales of
foreign exchange cause the home currency
to appreciate.
The signaling effect of intervention
• If market participants are unsure about the
future direction of macroeconomic policies,
sterilized intervention may give an
indication of where the central
bank expects (desires) the exchange rate
to move.
• Is the signaling effect “crying ‘wolf!’”?
• If governments do not follow up on their
exchange market signals with concrete
policy moves, the signals soon become
ineffective.
Reserve currencies in the world
monetary system
• Reserve currency: the currency
central banks hold in their international
reserves, and each nation’s central banks
fixes its currency’s exchange rate against
the reserve currency by standing ready to
trade domestic money for reserve assets at
that rate.
The mechanics of a reserve
currency standard
• Even though each central bank tied its
currency’s exchange rate only to dollar,
market forces automatically held all other
exchange rates (cross rates) constant at the
values implied by the dollar rate.
Fixed Exchange Rates under
currency-circulation system
• 纸币流通下的布雷顿森林体系。1944
• Bretton Woods agreement
• 英国向美国妥协的结果“双挂钩”体系。
1%幅度波动
1盎司=35美元
金块
美元dollar
各国货币
日元…
里拉…
The asymmetric position of the
reserve center
• The country whose currency is held as
reserves occupies a special position because
it never has to intervene in the foreign
exchange market.
• If there are N countries with N currencies in the
world, there are only N-1 exchange rates against
the reserve currency, there is no exchange rate for
the reserve center to fix. Thus the center countries
need never intervene and bears none of the burden
of financing its balance of payments.
• 各国货币钉住美元,而美元钉住什么?美国用不
着干预外汇市场。
Reserve center’s privilege
• The reserve center is the one country in the
system that can enjoy fixed exchange rates
without the need to intervene, it is still able
to use monetary policy for stabilizing
purposes.
The Gold Standard
• An international gold standard avoids the
asymmetry inherent in a reserve currency
standard by avoiding the “Nth currency”
problem. Under a gold standard, each
country fixes the price of its currency in
terms of gold by standing ready to trade
domestic currency for gold whenever
necessary to defend the official price.
Two kinds of the fixed
exchange rates
1. 金本位制度下的固定汇率制
2. 纸币流通制度下的固定汇率制
Gold Standard:规定货币单位的含金量。
含金量的的对比决定汇率。
金币可以自由铸造；自由兑换；自由输出
入。
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