Fixed And Floating Exchange Rate.
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LOG
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FIXED AND FLOATING EXCHANGE RATES INTERNATIONAL FINANCE
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CONTENTS 1 2 3
Evolution of IMS Flexible Exchange Rate Regime Role of International
4
Effects of BOP on Exchange Rate System
5
Floating Exchange Rate
6
Fixed Exchange
7
Exchange Arrangements
INTERNATIONAL FINANCE
EVOLUTION OF INTERNATIONAL MONETARY SYSTEM
www.themegallery.com
BIMETALLISM v Double standard in that free coinage was maintained for both gold and silver v Both gold & silver used as a means of international payment v The abundant metal was used as money E.g. When gold poured into the market in 1850s, the value of gold depressed, causing overvaluation of gold under the French official ratio, which equated a gold franc to a silver franc 15.5 times as heavy. So the franc became a gold currency
www.themegallery.com
CLASSICAL GOLD STANDARD
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INTER WAR PERIOD v Similar to Gold Standard but now central banks’ reserves consist of gold and currencies. v As the gold standard, the gold exchange standard restrains excessive monetary growth throughout the world. v But it allows more flexibility in the growth
www.themegallery.com
BRETTON WOODS v U.S. dollar is the reserve currency. v Every central bank fixes the dollar exchange rate of its currency through intervention. v Drawbacks of the Reserve-Currency Standard: – U.S. occupies a special position because it never has to intervene in the foreign exchange market – US can use its monetary policy for macroeconomic stabilization – US has the power to affect its own economy, as well as foreign economies by using monetary policy – Other central banks have to import the monetary policy of the US. – This inherent asymmetry led eventually to policy disputes within the system
www.themegallery.com
FLEXIBLE EXCHANGE RATE v 1973 to th e prese nt. v Aft er th e brea ku p of t he Bre tt on Woods syste m, th e cu rr enci es o f th e indust rialize d co untri es’ exch ange rate s were all owed to fl oat i n Ma rch 1 973. v Cu rr enci es of U. S., Ja pan, Ge rma ny and G reat B rit ain co nti nues to f lo at again st each oth er to th e prese nt.
www.themegallery.com
ROLE OF IMF Main goal of the IMF was: Avoiding repetition of the chaos that occurred between the wars through a combination of discipline and flexibility
Discipline
Flexibility
•fixed exchange rate regime imposed monetary discipline on countries, thereby curtailing price inflation
Meant that: •While monetary discipline was a central objective of the agreement, a rigid policy of fixed exchange rates would be too inflexible. •IMF was ready to lend foreign currencies to members to tide them over during short periods of balance-of-payments deficit, when a rapid tightening of monetary or fiscal policy would hurt domestic employment
Mean that: •Need to maintain a fixed exchange rate put a brake on competitive devaluations and brought stability to the world trade environment.
www.themegallery.com
Rate the government or central bank sets and maintains as the official exchange rate.
Determined by the private market through supply and demand
www.themegallery.com
EFFECTS ON BOP OF EXCHANGE RATE If currency value rises
If currency value falls
www.themegallery.com
FLOATING EXCHANGE RATE
www.themegallery.com
Monetary Policy Autonomy v Freedom (autonomy) for domestic monetary policy v No country is forced to import inflation (or deflation) from abroad. v Flexibility and the possibility for the country’s economy to be quickly adjusted to changing market conditions.
www.themegallery.com
Symmetry Floating exchange rates remove two main asymmetries of the Bretton Woods system and allow: – Central banks abroad to be able to determine their own domestic money supplies – The U.S. to have the same opportunity as other countries to influence its exchange rate against foreign
www.themegallery.com
Exchange Rates as Automatic Stabilizers
v Floating rates promote swift and relatively painless adjustment to certain shocks in the goods market, such as a fall in foreign demand for the country’s exports. v Figure 1 shows that a temporary fall in a country’s export demand reduces that country’s output more under a fixed rate than a floating rate.
www.themegallery.com
www.themegallery.com
FIXED EXCHANGE RATE
www.themegallery.com
Discipline v When central banks are free from the obligation to fix their exchange rates, they might embark on inflationary policies. v A stable (fixed) currency acts as a discipline on producers to keep their costs and prices down and may lead to greater pressure for exporters
www.themegallery.com
Destabilizing speculation and money market disturbances v Floating exchange rates allow destabilizing speculation. § Countries can be caught in a “vicious circle” of depreciation and inflation.
v Floating exchange rates make a country more vulnerable to money market disturbances.
www.themegallery.com
International Trade and Investment v Trade and Investment:
– Currency stability can help to promote trade and investment because of lower currency risk. – Exporters and importers face lower exchange risk. – International investments face lower uncertainty about their payoffs.
v Reductions in the cost of currency hedging – With fixed exchange rates, businesses have to spend less on currency hedging if they know that the currency will hold its value in the foreign exchange markets (hedging involves risk)
www.themegallery.com
The illusion of greater autonomy v Floating exchange rates increase the uncertainty in the economy without really giving macroeconomic policy greater freedom. – A currency depreciation raises domestic inflation due to higher wage settlements.
www.themegallery.com
Who Uses Fixed and Float List of exchange arrangements § Floating rates are used by many countries • Rich & poor • Large & small • All over the world
§ Pegged rates are used mostly by small countries § Largest number of countries are between fixed and floating
www.themegallery.com
Exchange Arrangements
Exchange Rate Regimes In Practice
www.themegallery.com
Currently: v14% of IMF members follow a free float policy v26% of IMF members follow a managed float system v28% of IMF members have no legal tender of their own vRemaining countries use less flexible systems such as pegged arrangements, or adjustable pegs
www.themegallery.com
Exchange Rate Regimes In Practice Exchange Rate Policies, IMF Members, 2006
www.themegallery.com
Exchange Rate System in India v Rupee linked to GBP till 1975 v In 1975, Rupee was delinked from GBP and pegged to a multi currency basket of currencies v Devaluation of Re in 1991 v 1992 –India moved from fixed regime of currency to a more controlled flexi regime, initiating liberalisation & globalisation.
www.themegallery.com
v Partial convertibility of Re, 40% to be sold to RBI and 60% at market rates v 1st March 1993 – Re came to be traded freely in the market, subject to exchange control and trade control regulations v USD became the intervention currency
www.themegallery.com
EXCHANGE RATES AT 16.50
INTERNATIONAL FINANCE
Conclusion v Replacement of new factors by new ones in the era of Globalization, Informatization and technical progress play the leading role. v Need of greater flexibility. v In case of poor economical policy and nonbalanced government management of the economy can reduce all the advantages of flexibility.
INTERNATIONAL FINANCE
v Liberalization of financial markets exceed the risks of instability, and the future is promising greater perspectives for the countries whose financial system is based on the floating exchange rate system
v Flexible exchange rate system offers better opportunities for successful economical development than fixed exchange rate system.
LOG
Thank You !
www.themegallery.com
FIXED AND FLOATING EXCHANGE RATES INTERNATIONAL FINANCE
www.themegallery.com
CONTENTS 1 2 3
Evolution of IMS Flexible Exchange Rate Regime Role of International
4
Effects of BOP on Exchange Rate System
5
Floating Exchange Rate
6
Fixed Exchange
7
Exchange Arrangements
INTERNATIONAL FINANCE
EVOLUTION OF INTERNATIONAL MONETARY SYSTEM
www.themegallery.com
BIMETALLISM v Double standard in that free coinage was maintained for both gold and silver v Both gold & silver used as a means of international payment v The abundant metal was used as money E.g. When gold poured into the market in 1850s, the value of gold depressed, causing overvaluation of gold under the French official ratio, which equated a gold franc to a silver franc 15.5 times as heavy. So the franc became a gold currency
www.themegallery.com
CLASSICAL GOLD STANDARD
www.themegallery.com
INTER WAR PERIOD v Similar to Gold Standard but now central banks’ reserves consist of gold and currencies. v As the gold standard, the gold exchange standard restrains excessive monetary growth throughout the world. v But it allows more flexibility in the growth
www.themegallery.com
BRETTON WOODS v U.S. dollar is the reserve currency. v Every central bank fixes the dollar exchange rate of its currency through intervention. v Drawbacks of the Reserve-Currency Standard: – U.S. occupies a special position because it never has to intervene in the foreign exchange market – US can use its monetary policy for macroeconomic stabilization – US has the power to affect its own economy, as well as foreign economies by using monetary policy – Other central banks have to import the monetary policy of the US. – This inherent asymmetry led eventually to policy disputes within the system
www.themegallery.com
FLEXIBLE EXCHANGE RATE v 1973 to th e prese nt. v Aft er th e brea ku p of t he Bre tt on Woods syste m, th e cu rr enci es o f th e indust rialize d co untri es’ exch ange rate s were all owed to fl oat i n Ma rch 1 973. v Cu rr enci es of U. S., Ja pan, Ge rma ny and G reat B rit ain co nti nues to f lo at again st each oth er to th e prese nt.
www.themegallery.com
ROLE OF IMF Main goal of the IMF was: Avoiding repetition of the chaos that occurred between the wars through a combination of discipline and flexibility
Discipline
Flexibility
•fixed exchange rate regime imposed monetary discipline on countries, thereby curtailing price inflation
Meant that: •While monetary discipline was a central objective of the agreement, a rigid policy of fixed exchange rates would be too inflexible. •IMF was ready to lend foreign currencies to members to tide them over during short periods of balance-of-payments deficit, when a rapid tightening of monetary or fiscal policy would hurt domestic employment
Mean that: •Need to maintain a fixed exchange rate put a brake on competitive devaluations and brought stability to the world trade environment.
www.themegallery.com
Rate the government or central bank sets and maintains as the official exchange rate.
Determined by the private market through supply and demand
www.themegallery.com
EFFECTS ON BOP OF EXCHANGE RATE If currency value rises
If currency value falls
www.themegallery.com
FLOATING EXCHANGE RATE
www.themegallery.com
Monetary Policy Autonomy v Freedom (autonomy) for domestic monetary policy v No country is forced to import inflation (or deflation) from abroad. v Flexibility and the possibility for the country’s economy to be quickly adjusted to changing market conditions.
www.themegallery.com
Symmetry Floating exchange rates remove two main asymmetries of the Bretton Woods system and allow: – Central banks abroad to be able to determine their own domestic money supplies – The U.S. to have the same opportunity as other countries to influence its exchange rate against foreign
www.themegallery.com
Exchange Rates as Automatic Stabilizers
v Floating rates promote swift and relatively painless adjustment to certain shocks in the goods market, such as a fall in foreign demand for the country’s exports. v Figure 1 shows that a temporary fall in a country’s export demand reduces that country’s output more under a fixed rate than a floating rate.
www.themegallery.com
www.themegallery.com
FIXED EXCHANGE RATE
www.themegallery.com
Discipline v When central banks are free from the obligation to fix their exchange rates, they might embark on inflationary policies. v A stable (fixed) currency acts as a discipline on producers to keep their costs and prices down and may lead to greater pressure for exporters
www.themegallery.com
Destabilizing speculation and money market disturbances v Floating exchange rates allow destabilizing speculation. § Countries can be caught in a “vicious circle” of depreciation and inflation.
v Floating exchange rates make a country more vulnerable to money market disturbances.
www.themegallery.com
International Trade and Investment v Trade and Investment:
– Currency stability can help to promote trade and investment because of lower currency risk. – Exporters and importers face lower exchange risk. – International investments face lower uncertainty about their payoffs.
v Reductions in the cost of currency hedging – With fixed exchange rates, businesses have to spend less on currency hedging if they know that the currency will hold its value in the foreign exchange markets (hedging involves risk)
www.themegallery.com
The illusion of greater autonomy v Floating exchange rates increase the uncertainty in the economy without really giving macroeconomic policy greater freedom. – A currency depreciation raises domestic inflation due to higher wage settlements.
www.themegallery.com
Who Uses Fixed and Float List of exchange arrangements § Floating rates are used by many countries • Rich & poor • Large & small • All over the world
§ Pegged rates are used mostly by small countries § Largest number of countries are between fixed and floating
www.themegallery.com
Exchange Arrangements
Exchange Rate Regimes In Practice
www.themegallery.com
Currently: v14% of IMF members follow a free float policy v26% of IMF members follow a managed float system v28% of IMF members have no legal tender of their own vRemaining countries use less flexible systems such as pegged arrangements, or adjustable pegs
www.themegallery.com
Exchange Rate Regimes In Practice Exchange Rate Policies, IMF Members, 2006
www.themegallery.com
Exchange Rate System in India v Rupee linked to GBP till 1975 v In 1975, Rupee was delinked from GBP and pegged to a multi currency basket of currencies v Devaluation of Re in 1991 v 1992 –India moved from fixed regime of currency to a more controlled flexi regime, initiating liberalisation & globalisation.
www.themegallery.com
v Partial convertibility of Re, 40% to be sold to RBI and 60% at market rates v 1st March 1993 – Re came to be traded freely in the market, subject to exchange control and trade control regulations v USD became the intervention currency
www.themegallery.com
EXCHANGE RATES AT 16.50
INTERNATIONAL FINANCE
Conclusion v Replacement of new factors by new ones in the era of Globalization, Informatization and technical progress play the leading role. v Need of greater flexibility. v In case of poor economical policy and nonbalanced government management of the economy can reduce all the advantages of flexibility.
INTERNATIONAL FINANCE
v Liberalization of financial markets exceed the risks of instability, and the future is promising greater perspectives for the countries whose financial system is based on the floating exchange rate system
v Flexible exchange rate system offers better opportunities for successful economical development than fixed exchange rate system.
LOG
Thank You !
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