7. Exchange Rate Regimes Flashcards
What are the two main goals of policymakers?
- Internal Balance
- Meaning price stability and full employment - External Balance
- meaning that their CA balance is neither too in debt nor too in surplus
What are the 3 main time periods between 1870-1973?
- The Gold Standard (1870-1914)
- Countries pegged their currency to gold
- U.K. was leading
- Interwar Period (1918-1939)
- Countries printed money in order to fund the war, leading to high inflation
- During the Geneva conference, they called for a return to the gold standard which turned out to be disastrous, especially for the U.K.
- Bretton Woods Systems (1946-1973)
- During the great depression, countries imposed capital controls, raised trade barriers, and depreciated their currencies
- The Bretton Woods systems were created after the great depression when countries realised they would have been better off had they cooperated
What are the 3 Bretton Woods systems?
- World Bank
Designed to help belligerent countries rebuild their shattered economies - International Monetary Fund
Designed to help countries achieve internal and external balance, as well as maintain stability in the international monetary system by raising living standards, encouraging sustainable growth, and alleviating poverty - International Trade Organisation
Designed to encourage the multilateral reduction of trade barriers
What are the goals and main business of the IMF?
Goals: -Promote monetary cooperation -Promote exchange rate stability -Facilitate the growth of international trade Business: -Economic and financial surveillance -Research and Data collection -Technical assistance and training -Lending
Why study fixed exchange rates?
- Manage floating regimes are an integral part of the international monetary system
- Clean float: government does not intervene and allows the currency to float in the foreign exchange market
- Dirty/Partial float: government does not fix the currency, but still tries to influence it through the central bank - Regional currency agreements
- Most developing countries peg their currencies
- Learning from past experiences
What are central bank open market operations and what’s their purpose?
- The sale and purchase of domestic assets that alters the money supply
- In order to hold the fixed exchange rate constant, the Central Bank must engage in open market operations to remove excess supply or demand and maintain the equilibrium condition
What is the money multiplier?
It’s the impact of the central bank’s transactions on the money supply being multiplied as a result of the initial purchase being deposited in the private banking system multiple times
What happens to monetary policy under a fixed exchange rate?
CB loses the ability to use monetary policy for the purpose of economic stabilisation
Why would a country want to depreciate its currency?
- To help fight unemployment at a time when fiscal policy is politically unpopular
- Improve its CA balance (X↑-IM↓)
- Central bank draws more reserves
What is a Balance of Payment (BoP) crisis?
Occurs when a country is no longer able to pay for essential imports or service its debts. Usually accompanied by a rapid decrease in the value of their currency.
-Expected decrease in the currency’s value leads to capital flight which triggers the BoP crisis
What is capital flight?
The rapid outflow of money out of a country
-The central bank responding by increasing interest rates accelerates capital flight because it slows down the economy by decreasing investment
Why should a country adopt a floating exchange rate?
- Restoration of monetary policy autonomy
- Symmetry
- The use of floating exchange rates as automatic stabilisers
What are the arguments against a floating exchange rate?
- Discipline
- Protects against speculative attacks
- Hurts international trade and investment
- Uncoordinated economics policies
- Illusion of greater autonomy
