Click to edit Master subtitle style
EXCHANGE RATES
GROUP 1
7/29/12
EXCHANGE RATES
An exchange rate between two currency is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency.
7/29/12
Fixed Exchange Rate
7/29/12
Fixed Exchange Rates
For a fixed exchange rate, the government is unwilling to let the country's currency float freely, and they state a level at which the exchange rate will stay. The government takes whatever measures that is necessary to maintain the rate and prevent it from fluctuating.
Click to edit Master subtitle style
7/29/12
Local Exchange Rate
•
In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged. 7/29/12
•
It is determined that the value of a single unit of local currency is equal to US$3, the central bank will have to ensure that it can supply the market with those dollars. In order to maintain the rate, the central bank must keep a high level of foreign reserves.
•
This is a reserved amount of foreign currency held by the central bank that it can use to release (or absorb) extra funds into (or out of) 7/29/12
•
•
Under the fixed exchange rate system, a decrease in the exchange rate which is infrequent are called revaluations. While an increase in the exchange rate are called devaluations.
•
7/29/12
•
A devaluation in a fixed exchange rate will cause the current account balance to rise, making a country's export less expensive for foreigners and also discourage import by making import products more expensive for domestic consumers. This will leads to an increase in trade surplus or a decrease in trade deficit.
•
The opposite happens in a revaluation. 7/29/12
•
Advantages of fixed Exchange Rates
The main arguments advanced in favor of the system of fixed or stable exchange rates are as follows: 1.Promotes international trade. Fixed or stable exchange rates ensure certainty about the foreign 7/29/12
4.
Removes Speculation: Fixed exchange rates eliminate the speculative activities in the international transactions. There is no possibility of panic flight of capital from one country to another in the system of fixed exchange rates. 5. Necessary for Developing Countries: Fixed exchanges rates are necessary and desirable for the developing countries for carrying out planned development efforts. Fluctuating rates disturb the smooth process of economic development and restrict the inflow of foreign capital. 6. Suitable for Currency Area: A fixed or stable exchange rate system is most suitable to a world of currency areas, such as the sterling area. If the exchange rates of the countries in the common currency area are flexible, the fluctuations in the leading country, like England (whose currency 7/29/12 dominates), will also disturb the exchange rates of the
7. Economic Stabilization: Fixed foreign exchange rate ensures internal economic stabilization and checks unwarranted changes in the prices within the economy. In a system of flexible exchange rates, the liquidity preference is high because the businessmen will like to enjoy wind fall gains from the fluctuating exchange rates. This tends to Increase price and hoarding activities in country.. 8. Other Arguments: Besides, the fixed exchange rate system is also beneficial on account of the following reasons. (i) It ensures orderly growth of world's money and capital markets and regularizes the international capital movements. (ii) It ensures smooth functioning of the international monetary system. That is why, IMF has adopted pegged or fixed exchange rate system. (iii) It encourages multilateral trade through regional cooperation of different countries. (iv) In modern times when economic transactions and relations among nations have become too vast and complex, it is more useful to follow a fixed exchange rate system.
7/29/12
DISADVANTAGES OF FIXED EXCHANGE RATE
1. 2. 3. 4. 5. 6.
Outmodel system Monetary dependence Discourage foreign investment Cost-price relationship not affected Not a genuinely fixed system Difficulties in International Monetary Fund system.
7/29/12
FLEXIBLE EXCHANGE RATE
7/29/12
FLEXIBLE EXCHANGE RATES
•
In case of a floating exchange rate, the value of a currency keeps on fluctuating in accordance with the movements of the foreign exchange market. they are adept at absorbing the aftereffects of critical financial crises. the exchange rate is determined entirely by the free market forces of demand and supply of currencies with no government intervention whatsoever.
•
•
7/29/12
The World Once Pegged
•
Between 1870 and 1914, there was a global fixed exchange rate. At the end of World War II It was agreed that currencies would once again be fixed. the peg was used only at a time when all the major economies were a part of it. while a floating regime has proved to be a more efficient means of determining the long-term value of a currency and creating equilibrium in the international market.
•
•
7/29/12
Advantages of flexible interest rate
1.The main advantage of this system is its flexibility and possibility for the country's economy to be quickly adjusted to the changing market conditions. 2.There is automatic correction in the floating exchange rate as the country simply let it move freely to the equilibrium of demand and supply. 3.The free movement of demand and supply helps to insulate the domestic economy from the world economy fluctuations. 4.It automatically determines interest rate within the country and therefore allows controlling the economic balance more effectively. 5.It allows the government to allows the government to introduce 7/29/12 separate monitory and fiscal policies, which is rather difficult under
Disadvantages OF FLOATING RATE
•
This exchange rate system leads to instability. Floating exchange rates destabilize economical situation. Work of Milton Friedman in 1953 Caused by wrong economical policy of the governments and other factors.
•
•
•
7/29/12
•
•
Exchange Rate being unstable and uncertain under the floating exchange rate regime. Speculation tends to be higher in the floating exchange rate regime It leading to more uncertainty especially for traders and investors.
•
•
7/29/12
GERMANY IN 1980’S
q
Facts: DM shifted from 20% above the purchasing power of USD to 25% below this level Then returned to 25% above USD purchasing power. Predictions: This shift has to cause significant
•
•
q
•
7/29/12
Dornbush in 1976
q
Suggestion: Phenomenon of «over-shooting». Means: Need to depreciate its currency. Effects: Cause the decrease of interest rates and the fall of activity. Solution:
•
q
•
q
•
7/29/12 q
Dornbush in 1976
q
Variant: The fall of the currency lower than it's needed in the long run. Example: If the money supply of the country rises by 5%, its currency needs to be depreciated by 5% in the long run.
•
q
•
But to stimulate economical activity 7/29/12
v
FEAR OF FLOATING
•
increases foreign exchange volatility. high liability dollarization, financial fragility, strong balance sheet effects When liabilities are denominated in foreign currencies while assets are in the local currency, unexpected depreciations of the exchange rate deteriorate bank and threaten the stability of the domestic financial system.
•
•
7/29/12
7/29/12
doc_395376050.pptx
EXCHANGE RATES
GROUP 1
7/29/12
EXCHANGE RATES
An exchange rate between two currency is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency.
7/29/12
Fixed Exchange Rate
7/29/12
Fixed Exchange Rates
For a fixed exchange rate, the government is unwilling to let the country's currency float freely, and they state a level at which the exchange rate will stay. The government takes whatever measures that is necessary to maintain the rate and prevent it from fluctuating.
Click to edit Master subtitle style
7/29/12
Local Exchange Rate
•
In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged. 7/29/12
•
It is determined that the value of a single unit of local currency is equal to US$3, the central bank will have to ensure that it can supply the market with those dollars. In order to maintain the rate, the central bank must keep a high level of foreign reserves.
•
This is a reserved amount of foreign currency held by the central bank that it can use to release (or absorb) extra funds into (or out of) 7/29/12
•
•
Under the fixed exchange rate system, a decrease in the exchange rate which is infrequent are called revaluations. While an increase in the exchange rate are called devaluations.
•
7/29/12
•
A devaluation in a fixed exchange rate will cause the current account balance to rise, making a country's export less expensive for foreigners and also discourage import by making import products more expensive for domestic consumers. This will leads to an increase in trade surplus or a decrease in trade deficit.
•
The opposite happens in a revaluation. 7/29/12
•
Advantages of fixed Exchange Rates
The main arguments advanced in favor of the system of fixed or stable exchange rates are as follows: 1.Promotes international trade. Fixed or stable exchange rates ensure certainty about the foreign 7/29/12
4.
Removes Speculation: Fixed exchange rates eliminate the speculative activities in the international transactions. There is no possibility of panic flight of capital from one country to another in the system of fixed exchange rates. 5. Necessary for Developing Countries: Fixed exchanges rates are necessary and desirable for the developing countries for carrying out planned development efforts. Fluctuating rates disturb the smooth process of economic development and restrict the inflow of foreign capital. 6. Suitable for Currency Area: A fixed or stable exchange rate system is most suitable to a world of currency areas, such as the sterling area. If the exchange rates of the countries in the common currency area are flexible, the fluctuations in the leading country, like England (whose currency 7/29/12 dominates), will also disturb the exchange rates of the
7. Economic Stabilization: Fixed foreign exchange rate ensures internal economic stabilization and checks unwarranted changes in the prices within the economy. In a system of flexible exchange rates, the liquidity preference is high because the businessmen will like to enjoy wind fall gains from the fluctuating exchange rates. This tends to Increase price and hoarding activities in country.. 8. Other Arguments: Besides, the fixed exchange rate system is also beneficial on account of the following reasons. (i) It ensures orderly growth of world's money and capital markets and regularizes the international capital movements. (ii) It ensures smooth functioning of the international monetary system. That is why, IMF has adopted pegged or fixed exchange rate system. (iii) It encourages multilateral trade through regional cooperation of different countries. (iv) In modern times when economic transactions and relations among nations have become too vast and complex, it is more useful to follow a fixed exchange rate system.
7/29/12
DISADVANTAGES OF FIXED EXCHANGE RATE
1. 2. 3. 4. 5. 6.
Outmodel system Monetary dependence Discourage foreign investment Cost-price relationship not affected Not a genuinely fixed system Difficulties in International Monetary Fund system.
7/29/12
FLEXIBLE EXCHANGE RATE
7/29/12
FLEXIBLE EXCHANGE RATES
•
In case of a floating exchange rate, the value of a currency keeps on fluctuating in accordance with the movements of the foreign exchange market. they are adept at absorbing the aftereffects of critical financial crises. the exchange rate is determined entirely by the free market forces of demand and supply of currencies with no government intervention whatsoever.
•
•
7/29/12
The World Once Pegged
•
Between 1870 and 1914, there was a global fixed exchange rate. At the end of World War II It was agreed that currencies would once again be fixed. the peg was used only at a time when all the major economies were a part of it. while a floating regime has proved to be a more efficient means of determining the long-term value of a currency and creating equilibrium in the international market.
•
•
7/29/12
Advantages of flexible interest rate
1.The main advantage of this system is its flexibility and possibility for the country's economy to be quickly adjusted to the changing market conditions. 2.There is automatic correction in the floating exchange rate as the country simply let it move freely to the equilibrium of demand and supply. 3.The free movement of demand and supply helps to insulate the domestic economy from the world economy fluctuations. 4.It automatically determines interest rate within the country and therefore allows controlling the economic balance more effectively. 5.It allows the government to allows the government to introduce 7/29/12 separate monitory and fiscal policies, which is rather difficult under
Disadvantages OF FLOATING RATE
•
This exchange rate system leads to instability. Floating exchange rates destabilize economical situation. Work of Milton Friedman in 1953 Caused by wrong economical policy of the governments and other factors.
•
•
•
7/29/12
•
•
Exchange Rate being unstable and uncertain under the floating exchange rate regime. Speculation tends to be higher in the floating exchange rate regime It leading to more uncertainty especially for traders and investors.
•
•
7/29/12
GERMANY IN 1980’S
q
Facts: DM shifted from 20% above the purchasing power of USD to 25% below this level Then returned to 25% above USD purchasing power. Predictions: This shift has to cause significant
•
•
q
•
7/29/12
Dornbush in 1976
q
Suggestion: Phenomenon of «over-shooting». Means: Need to depreciate its currency. Effects: Cause the decrease of interest rates and the fall of activity. Solution:
•
q
•
q
•
7/29/12 q
Dornbush in 1976
q
Variant: The fall of the currency lower than it's needed in the long run. Example: If the money supply of the country rises by 5%, its currency needs to be depreciated by 5% in the long run.
•
q
•
But to stimulate economical activity 7/29/12
v
FEAR OF FLOATING
•
increases foreign exchange volatility. high liability dollarization, financial fragility, strong balance sheet effects When liabilities are denominated in foreign currencies while assets are in the local currency, unexpected depreciations of the exchange rate deteriorate bank and threaten the stability of the domestic financial system.
•
•
7/29/12
7/29/12
doc_395376050.pptx