Exchange Rate Regimes and the International Financial System

Question 1

What is an Unsertilised Foreign Exchange intervention?

Answer 1

Occurs when a central bank allows B to respond to the sale or purchase of domestic currency in the forex market

Question 2

What is an stertilised Foreign Exchange intervention?

Answer 2

• Occurs when a forex intervention is accompanies by offsetting domestic open market operations, so that B is unchanged
• Because the monetary base is unaffected, domestic interest rates will not change
• So, demand curve and supply curve for dollars will no be affects, and exchange rate will not change
• To be effective, central bank interventions that are intended to change the exchange rate need to be unsterilised

Question 3

What is the BoP?

Answer 3

• Accounts are a measure of all flows of private and government funds between a domestic economy and all foreign countries
• Inflows of funds from foreigners are receipts, which are recorded positively
• Outflows of funds from foreigners are payments, which are recorded negatively
• Current Accounts
  
  • International transactions that involve currently produced goods and services
  • Trade balance
• Capital Account
  
  • Net receipts from capital transactions

Question 4

What is a fixed exchange rate regime?

Answer 4

• Value of a currency is pegged relative to the value of another (anchor)
• When the domestic currency is overvalued, the CB must purchase domestic currency to keep the exchange rate fixed (it loses international reserves), or conduct a devaluation
• When the domestic currency is undervalued, the CB must sell domestic currency to keep the exchange rate fixed (it gains international reserves), or conduct a revaluation

Question 5

What is the policy trilemma?

Answer 5

• Free capital mobility and fixed exchange rate: HK
• Fixed exchange rate and independent MP: China
• Independent MP and free capital mobility: USA

Question 6

What happens when a CB sells foreign assets?

Answer 6

A central banks purchase of domestic currency and sale of foreign assets leads to an EQUAL decline in international reserves (Assets) and the monetary base (R in liabilities)

Question 7

What happens to B when the Fed purchases $10 billion of foreign assets?

Answer 7

The monetary base increases by $10 billion because bank reserves will increase by that amount.

Question 8

What happens to B when The Fed sells $10 billion of foreign assets and purchases $10 billion of Treasury securities?

Answer 8

The monetary base does not change because the effects of the two actions on the base offset.

Question 9

What happens to B when The Fed conducts a sterilized foreign exchange intervention?

Answer 9

The monetary base does not change because sterilized foreign exchange interventions do not affect the base.

Question 10

What happens to B when The Fed sells $10 billion of foreign assets and sells $10 billion of Treasury securities?

Answer 10

The monetary base decreases by $20 billion because bank reserves will fall by that amount.

Question 11

Why might China’s currency be more volatile now?

Answer 11

China pegged the Yuan to the U.S. dollar from 1994 to mid-2005 and to a basket of currencies from mid-2008 to mid-2010, after which China has allowed the value of the yuan to rise somewhat against the dollar.

Question 12

What is wrong with fixed regimes?

Answer 12

Domestic monetary policy in the pegging country is dependent on foreign business cycles, meaning that there is no scope for domestic monetary policy stabilization. May be forced to import a contractionary policy, which could create unexpected and undesirable contraction in the domestic economy.

Question 13

What will a contractionary US policy do to FX that are pegged to the dollar?

Answer 13

• An increase in U.S. interest rates will increase the demand for dollar assets and reduce the demand for foreign assets which will appreciate the dollar and depreciate the foreign currency.
• In order to maintain the peg, the foreign CB must increase domestic interest rates by selling foreign assets, and buying domestic currency.

Question 14

How can the CB utilise a sterilised intervention to appreciate the currency?

Answer 14

Domestic currency is bought and foreign assets are sold, leading to a fall in international reserves, a fall in the money supply, a rise in domestic interest rates, and an increase in dollar asset demand

Question 15

How can the CB utilise a sterilised intervention to appreciate the currency?

Answer 15

Domestic currency is sold and foreign assets bought, leading to a rise in international reserves, a rise in MS, a fall in domestic interest rates and reduction is dollar asset demand