Download File

Exchange Rate Arrangements:
Various Options
Choice before an authority
– Fixed Exchange Rate System
– Floating Exchange Rate System
Exchange Rate Arrangements:
Various Options
THE CASE FOR FLOATING EXCHANGE RATES
• 1. Monetary policy autonomy.
• If central banks were no longer obliged to
intervene in currency markets to fix exchange
rates, authorities would be able to use
monetary policy to reach internal and external
balance.
• Further, no country would be forced to import
inflation (or deflation) from abroad.
Exchange Rate Arrangements:
Various Options
• 2. Symmetry.
• Under a system of floating rates the inherent
asymmetries of Bretton Woods would
disappear and the United States would no
longer be able to set world monetary condition
all by itself.
• At the same time, the United States would
have the same opportunity as other countries
to influence its exchange rate against foreign
currencies.
Exchange Rate Arrangements:
Various Options
•
3. Exchange rates as automatic stabilizers.
• Even in the absence of an active monetary
policy, the swift adjustment of marketdetermined exchange rates would help
countries maintain internal and external
balance in the face of changes in aggregate
demand.
• The long and agonizing period of speculation
preceding exchange rate realignments under
the Bretton Woods rules would not occur
under floating.
Exchange Rate Arrangements:
Various Options
• THE CASE AGAINST FLOATING
•
EXCHANGE RATES
1. Discipline.
• Central banks freed from the obligation to fix
their exchange rates might embark on
inflationary policies.
• In other words, the "discipline" imposed on
individual countries by a fixed rate would be
lost.
Exchange Rate Arrangements:
Various Options
• 2. Destabilizing speculation and money
market disturbances.
• Speculation on changes in exchange rates
could lead to instability in foreign exchange
markets, and this instability, in turn, might
have negative effects on countries' internal and
external balances.
• Further, disturbances to the home money
market could be more disruptive under
floating than under a fixed rate.
Exchange Rate Arrangements:
Various Options
• 3. Injury to international trade and
investment.
• Floating rates would make relative
international prices more unpredictable
and thus injure international trade and
investment.
Exchange Rate Arrangements:
Various Options
• 4. Uncoordinated economic policies.
• If the Bretton Woods rules on exchange rate
adjustment were abandoned, the door would
be opened to competitive currency practices
harmful to the world economy.
• As happened during the interwar years,
countries might adopt policies without
considering their possible beggar-thy-neighbor
aspects.
• All countries would suffer as a result.
Exchange Rate Arrangements:
Various Options
•
5. The illusion of greater autonomy.
• Floating exchange rates would not really give
countries more policy autonomy.
• Changes in exchange rates would have such pervasive
macroeconomic effects that central banks would feel
compelled to intervene heavily in foreign exchange
markets even without a formal commitment to peg.
• Thus, floating would increase the uncertainty in the
economy without really giving macroeconomic policy
greater freedom.
Exchange Rate Arrangements:
Various Options
Various Alternatives Available Under Floating
Exchange Rate System
1.
2.
3.
4.
5.
6.
7.
8.
9.
Free Float
Dirty Float
Floating Within A Band
Sliding Band
Crawling Band
Crawling Peg
Fixed but Adjustable
Currency Board
Dollarization
Exchange Rate Arrangements:
Various Options
Free Float
•
•
Value of foreign exchange freely determined in the market.
Actual and expected changes in demand/ supply of assets
and goods reflected in exchange rate changes
Exchange Rate Arrangements:
Various Options
Dirty Float
•
•
•
•
Sporadic central bank interventions in foreign exchange
markets.
Modes and frequency of intervention vary as do the
objectives guiding the interventions.
Active interventions results in changes in international
reserves.
Indirect interventions (through changes in interest rates,
liquidity and other financial instruments) does not result in
changes in reserves
Exchange Rate Arrangements:
Various Options
Floating Within A Band
•
•
•
•
•
The exchange rate is allowed to fluctuate within a band.
The center of the band is a fixed rate, either in terms of
one currency or of a basket of currencies.
The width of the band varies.
Some band systems are the result of cooperative
arrangements, other are unilateral
Example:
(The Vietnam government announced a raft of plans, including widening the
currency trading band, to help counter the nation’s fastest inflation in more
than 12 years. It plans to widen the currency’s trading band against the dollar
to 2%, up from the current 0.75%. (7 March 2008))
Exchange Rate Arrangements:
Various Options
Sliding Band
•
•
•
There is no commitment by the authorities to maintain the
central parity "indefinitely" .
Instead it is clear at the outset that the central parity will be
adjusted periodically (e.g. due to competitiveness
considerations)
The system is an adaptation of the band regime to the case
of high inflation economies.
Exchange Rate Arrangements:
Various Options
Crawling Band
•
•
•
•
A band system whereby the central parity crawls overtime.
Different rules can be used to determine the rate of crawl.
The two most common are backward looking crawl (e.g.
based on past inflation differential ) and
forward looking crawl (e.g. based on the expected or
target, rate of inflation)
Exchange Rate Arrangements:
Various Options
Crawling Peg
•
•
The normal exchange rate is adjusted periodically
according to a set of indicator (usually lagged inflation
differentials) and is not allowed the alternate beyond a
narrow range (say two percent)
One variant of the system consists of adjusting the
nominal rate by a pre-announced rate set deliberately
below ongoing inflation.
Exchange Rate Arrangements:
Various Options
Fixed but Adjustable
•
•
•
•
The regime epitomized by the Bretton Woods System.
The exchange rate is fixed but the central bank is not obliged
to maintain the parity indefinitely.
No tight constraints are imposed on the monetary and fiscal
authorities regarding policies that are inconsistent with
preserving the parity.
Adjustments of the parity (devaluation) are a powerful policy
instrument
Exchange Rate Arrangements:
Various Options
Currency Board
•
•
Fixed exchange rate system with institutional (legal and
even constitutional) constraints on monetary policy and no
scope for altering the parity.
The monetary authority can issue domestic money only
when it is fully backed by inflows of foreign exchange
Exchange Rate Arrangements:
Various Options
Dollarization
•
Generic name given to and extreme form of a currency
board system where the country gives up completely its
monetary autonomy by adopting another countries
currency