Exchange Rates FREELY FLOATING CLEAN FLOATING RIGIDLY FIXED EXCHANGE RATES DIRTY FLOATING MANAGED FLOATING ADJUSTABLE PEG EXCHANGE RATES
Measuring the exchange rate Spot Exchange Rate - This is determined by the FOREX market on a minute-by-minute basis on the basis. Forward Exchange Rate - a forward rate involves the delivery of currency at some time in the future at an agreed rate. Companies wanting to reduce risk Real Exchange Rate - this measure is the ratio of domestic price indices between two countries. A rise in the real exchange rate implies a worsening of international competitiveness for a country.
Free Floating Exchange Rate The value of £ is determined purely by S & D of the currency Sterling has floated freely since the UK suspended membership of the ERM in September 1992
Managed Floating Exchange Rate The value of the pound determined by market demand for and supply of the currency Central banks may to try to iron out big changes in exchange rates on a day-to-day basis Managed floating was a policy pursued from 1973-1990
Semi-Fixed Exchange Rates Adjustable Peg The exchange rate is given a specific target The currency can move between permitted bands on a day-to-day basis The National Bank might have to intervene to maintain the value of the currency.
Fully-Fixed Exchange Rates The government makes a commitment to a fixed exchange rate There are no fluctuations from the central rate System achieves exchange rate stability but perhaps at the expense of domestic stability
Fixed versus floating exchange rates – which is best for an economy? 1973-1990: UK operated with a managed floating exchange rate. Intervention by BoE and govt controlled interest rates. October 1990- September 1992: UK a member of the European exchange rate mechanism (ERM) – the exchange rate was a specific target of economic policy. September 1992 – present day: the UK has operated with a free-floating exchange rate
1992: UK crashes out of ERM The government has suspended Britain's membership of the ERM The UK's prime minister and chancellor tried all day to prop up a failing £. Chancellor Norman Lamont raised interest rates from 10% to 12%, then to 15% then back to 12% on same day.
Black Wednesday • George Soros the most high profile of the currency market investors, made over 1 billion GBPprofit by short selling sterling.
Black Wednesday • Treasury spent £27 billion of reserves in propping up the pound.
Greece and Euro? Stability and Growth Pact 1997Maastricht convergence criteria Annual budget deficit no higher than 3% of GDP a national debt lower than 60% of GDP
The case for floating exchange rates: Reduced need for currency reserves to prop up the currency: Useful macroeconomic instrument Partial correction for a trade deficit: Reduced risk of currency speculation: Freedom (autonomy) for domestic monetary policy:
The Case for Fixed Exchange Rates Trade and Investment: Currency stability Some flexibility permitted: Disciplines on domestic producers: Reinforcing gains in comparative advantage
Kazakhstan • September 2, 2013, Kazakhstan will peg its tengeto:- • Euro 20% • US dollar 70% • Rouble 10%
Marshall-Lerner Condition and J Curve • when does a real devaluation improve the current-account balance of a country? • Exportsped+Importsped > 1
Rationale behind J-Curve • In short run after a devaluation, M and X will remain unchanged. • In the long run consumers will have a chance to adjust.