Topic 1 and 2 Flashcards
What are 5 factors that cause shifts in the supply / demand curve for local currency?
- Level of domestic income
- Changes in Foreign Income levels
- Interest rate differentials
- Expectations
- Exogeneous factors
What is an exchange rate regime?
How government, through the central bank / an appointed authority, manages the currency of the country & the foreign exchange market.
What is a floating exchange rate?
Entirely market-determined. No government restrictions or interventions
What two floating exchange rates do the IMF distinguish between?
- Free-floating rate: fx intervention limited. Moderate rate of change and prevent undue fluctuations
- Floating rate: intervene more regularly to influence, but not specific exchange rate path or target
What are the 5 types of soft pegs used in exchange rate regimes?
- Conventional fixed to currency or basket
- Stabilised arrangement
- Pegged with horizontal bands
- Crawling peg exchange rate
- Crawl-like arrangement
What is a stabilised arrangement soft peg?
The spot rate is fixed at a 2% margin of another currency for 6+ months, but does not imply a policy commitment
What is a soft peg with horizontal bands?
aka. Targeted exchange rate regime.
Fluctuate within a band around a fixed reference point.
What is a crawling peg exchange rate?
Adjusted periodically at preannounced fixed rate or in response to changes in selective indicators (ie. inflation)
What is a crawl-like arrangement?
Within crawling bands. Pegged within bands that periodically shifts
What are examples of hard pegs?
No separate legal tender. Includes dollarization, monetary unions and currency boards.
What are the 3 different factors in Mundell-fleming’s impossible trinity?
Fixed exchange rate, free capital movement, independent monetary policy
What are the central issues when comparing pegged vs floating regimes?
- Independence of the monetary policy
- Ability to handle shocks to the domestic economy & those of other countries
- Need for capital controls
- Need for foreign exchange reserves
- Stability
- Speculation & hot money flows
What is a non-sterilized form of exchange rate intervention?
The central bank uses foreign reserves to purchase domestic currency from a commercial bank. Over time, reduced money supply will lead to higher interest rates and lower inflation, with such effects also contributing to an appreciation of the domestic currency over time.
What is a sterilized form of exchange rate intervention?
Offsetting the balance sheet position, to avoid the inflation threat. The same time the Central Bank sells the foreign currency, they buy domestic government bonds, therefore increasing the money supply. This doesn’t influence the domestic interest rate, but can still influence the exchange rate
How can a sterilized exchange rate intervention still influence the exchange rate?
- the portfolio balance channel
- the microstructure channel
- the signalling or expectations channel
What is a monetary union?
the portfolio balance channel
the microstructure channel
the signalling or expectations channel
An economic and monetary union combines a monetary union with an economic union (a common market and a customs union) e.g. Eurozone.
Dollarization
Dollarization occurs when the US dollar (or other foreign currency) is used alongside or instead of the domestic currency as money, essentially as a means of payment and unit of account (currency substitution). It also includes holding foreign currency-denominated assets in a domestic bank (asset substitution)
What are the pro’s of dollarization?
Reduce country risk - investment climate
Protect against inflation & devaluation
What are the cons of dollarization?
- Loss of monetary policy
- Loses seigniorage
- Lose lender of last resort
What are the two types of dollarization?
Official (de jure) - almost permanent, formal agreement
Unofficial (de facto) - use forex in transactions but no formal policy
What drove dollarization in Angola?
- a long conflict
- poor macroeconomic conditions in the early 2000s (hyperinflation)
- the value of the kwanza and
- the reliance of the country on oil revenue.
What are key success factors to dedollarization?
- Strong macroeconomic policies
- Presence of inflation targeting
- lower international interest rates
- lower volatility in global stock markets
Explain the controversy regarding the Chinese Yuan?
The Chinese maintained a peg within fixed bands to the USD, making their exports more competitive. This is achieved by buying dollars and selling Yuan, and has lead to $3.82 million in USD reserves. The general opinion is that this exchange rate regime has left the currency undervalued (and therefore increases the competitiveness)
