1、Huang zhiyong,Nanjing University of Finance&Economics Tel：84028241,INTERNATIONAL FINANCE,Chapter SIX：Government Policies toward the Foreign Exchange Market,This Chapter first presents the Floating exchange rate and Fixed exchange rate.Then discuss the Defense through official intervention.The last s
2、ection explains Exchange control and International Currency Experience.,Government Policies Toward the Foreign Exchange Market,Two Aspects:the choice between a floating exchange rate and a fixed exchange rate.Restrictions or exchange controls.,一、Floating exchange rate,A clean float:If government pol
3、icy lets the market determine the exchange rate,the rate is free to go wherever the market equilibrium is at that time.A managed float or a dirty float:the government often tries to have a direct impact on the rate through official intervention.,二、Fixed exchange rate,What to fix to?GoldU.S.dollar or
4、 any other single currencyA Basket of foreign currencies The special drawing right(SDR)Or create its own basket,When to change the fixed rate?Never(not credible)：a polar caseSeldom(adjustable peg)Often(crawling peg),How to defend the fixed rate?Intervention in the FX marketExchange controlAlter dome
5、stic interest ratesMacroeconomic adjustment Or surrender rather than defend,三、Defense through official intervention,1.Defending against depreciation,For instance,a Latin American country is attempting to maintain a fixed rate of 25 pesos per dollar,with a Band of plus or minus 4 percent.Nonofficial
6、supply and demand are attempting to pushThe exchange rate to 28 pesos per dollar,the intersectionWhere the market would clear on its own.,Figure 6.1Intervention to Prevent Depreciation,This results in an official settlements balance deficit.Through intervention the monetary authority is financing th
7、e countrys deficit in its official settlement balance.The authority either uses its own official international reserve assets to obtain dollars or it borrows the dollars.,Where does the monetary authority get the dollar to sell into the foreign exchange rate,Uses its own official international reser
8、veForeign exchange assetsSpecial drawing rightsReserve position in the IMFGoldBorrow the dollarsSome countries maintain arrangements called swap linesBorrow dollars from private sources.,What is the implication of the other part of the intervention?Sterilized intervention:the authority take action t
9、o prevent the domestic money supply from changingIf no sterilization,the change in the domestic money supply will alter domestic interest rates and influence the entire macroeconomy of the country,2.Defending against appreciation,For instance,an Asian country is attempting to maintain a fixed rate o
10、f 100“locals”per dollar,with a Band of plus or minus 5 percent.Nonofficial supply and demand are attempting to pushthe exchange rate to 85 locals per dollar,the intersectionWhere the market would clear on its own.,Figure 6.3Intervention to Prevent Appreciation,This results in an official settlements
11、 balance surplusAdds official reserve holdings,What is the implication of the other part of the intervention?Expand the domestic money supplyIf no sterilization,the interest rates and the entire macroeconomy of the country are likely to be affected.,3.Temporary DisequilibriumIf imbalances are clearl
12、y temporary,then defending the fixed exchange rate purely through intervention can work and makes sense.,Temporary Disequilibrium,1.40,1.60,1.80,B,D,E,A,C,S,S,D,40,50,60,Autumn-winter,Exchange rate($per),biliions,Spring-summer,The official financing of spring-summer deficits with autumn-winter forei
13、gn exchange reserves brings a net social gain to the world.,Disequilibrium that is not temporary,Continually losing reserves if the imbalance is a deficit.An example of a failed defense of a currency:The depreciation of the Mexican peso in late 1994.,continually accumulating reserves if the imbalanc
14、e is a surplus.The rate of return on this particular form of national wealth tends to be low.The value of foreign-exchange assets will decline if the country eventually must“retreat”by revaluing its own currency.May be viewed as too large by other countries.An example of Japan in the early 1970s.,Th
15、e conclusion is fundamental disequilibrium calls for adjustment,not merely financing.,四、Exchange control,It can be indicated as socially inferior to the others,but it is widely used.It closely analogous to quantitative restrictions(quotas)on imports.An oversimplified example(Figure 6.5),Figure 6.5Ex
16、change Control,From this example,we can seeIt give the government a large amount of revenues which taken from importers and exportersIt imposes a loss of well-being on society as a whole.,Actual exchange control regimes are likely to have several other effects and costs:Allocate the right to buy for
17、eign currency.A second foreign exchange marketa parallel or black market emerged,Why use it?To defend a fixed rate,reduce economic uncertaintyA device as increasing the government officials power over the allocation of resources.,International Currency Experience,Bimetallism:Before 1870Classical Gol
18、d Standard:1870-1914Interwar Period:1915-1944Bretton Woods System:1945-1973The Flexible Exchange Rate Regime:1973-Present,Bimetallism:Before 1870,both gold and silver were used as money.Some countries were on the gold standard,some on the silver standard,some on both.Both gold and silver were used a
19、s international means of payment and the exchange rates among currencies were determined by either their gold or silver contents.,Classical Gold Standard:1870-1914,Emerged by 1870 with the help of historical accidentsBritain was the central countryBritain tied the pound sterling ever more closely to
20、 gold than to silver.The silver-mining expansion of the 1870s and 1880s.Under this system,Gold value of each currency was fixed.The exchange rate between two countrys currencies would be determined by their relative gold contents.,For example,if the dollar is pegged to gold at U.S.$30=1 ounce of gol
21、d,and the British pound is pegged to gold at 6=1 ounce of gold,the exchange rate is determined by the relative gold contents:,$30=6$5=1,Highly stable exchange rates under the classical gold standard provided an environment that was conducive to international trade and investment.Misalignment of exch
22、ange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism.,Price-Specie-Flow Mechanism,Suppose Great Britain exported more to France than France exported to Great Britain.This cannot persist under a gold standard.The resultant change in relati
23、ve price levels will slow exports from Britain and encourage exports from France.,BOP,Surplus,Deficit,Gold import,Ms expand,Price increase,X decreaseM increase,Gold export,Ms tighten,Price decrease,X increaseM decrease,equilibrium,Price SpecieFlowMechanism,There are shortcomings:The supply of newly
24、minted gold is so restricted that the growth of world trade and investment can be hampered for the lack of sufficient monetary reserves.Even if the world returned to a gold standard,any national government could abandon the standard.,Interwar Period:1915-1944,Exchange rates fluctuated as countries w
25、idely used“predatory”depreciations of their currencies as a means of gaining advantage in the world export market.Attempts were made to restore the gold standard,but participants lacked the political will to“follow the rules of the game”.The result for international trade and investment was profound
26、ly detrimental.,Bretton Woods System:1945-1973,Named for a 1944 meeting of 44 nations at Bretton Woods,New Hampshire.The purpose was to design a postwar international monetary system.The goal was exchange rate stability without the gold standard.The result was the creation of the IMF and the World B
27、ank.,Bretton Woods System:1945-1973,Under the Bretton Woods system,the U.S.dollar was pegged to gold at$35 per ounce and other currencies were pegged to the U.S.dollar.Each country was responsible for maintaining its exchange rate within 1%of the adopted par value by buying or selling foreign reserv
28、es as necessary.The Bretton Woods system was a dollar-based gold exchange standard.,Bretton Woods System:1945-1973,U.S.dollar,Gold,Pegged at$35/oz.,The Flexible Exchange Rate Regime:1973-Present.,Flexible exchange rates were declared acceptable to the IMF members.Central banks were allowed to interv
29、ene in the exchange rate markets to iron out unwarranted volatilities.Gold was abandoned as an international reserve asset.Non-oil-exporting countries and less-developed countries were given greater access to IMF funds.,Current Exchange Rate Arrangements,Free Float The largest number of countries,ab
30、out 48,allow market forces to determine their currencys value.Managed Float About 25 countries combine government intervention with market forces to set exchange rates.Pegged to another currency Such as the U.S.dollar or euro.No national currencySome countries do not bother printing their own,they j
31、ust use the U.S.dollar.For example,Ecuador,Panama,and El Salvador have dollarized.,European Monetary System,Led by West Germany and France,the EMS was launched in 1979.Objectives:To establish a zone of monetary stability in Europe.To coordinate exchange rate policies vis-vis non-European currencies.
32、To pave the way for the European Monetary Union.,International monetary system timeline,1944 The conference at Bretton Woods establishes the gold exchange standard and creates the IMF and the IBRD(the World Bank);1948 The Bill appropriating funds for the reconstruction of Europe,the Marshall Plan,is
33、 signed.1949 Devaluation of the currencies of the major European and many other countries.,1950 the European Payment Union(EPU)is created by recipients of the Marshall Plan.1958 The European Economic Community(EEC)is established and the EPU is abolished.Most European countries restore convertibility
34、 of their currencies into dollars and gold for non-residents.1960 A run on gold causes the creation of the London gold pool by the major central banks in order to hold down the price of gold.,1961 OECD comes into existence.1962 the French begin selling dollars for gold.1963 United States levies the
35、interest equalization tax on non-resident borrowers.1965 United States Imposes“voluntary”controls on foreign investment by US residents.,1967 A world monetary crisis follows the devaluation of the British pound.1968 Voluntary controls on foreign investment become mandatory,A new run on gold forces g
36、overnments to abandon the London gold pool adopt a two-tiered gold market where central banks trade at the official price and private transactions take place at the market price.,1969 The French franc devalues,The German mark revalues after a short float.SDRs are created.1971US runs its first trade
37、deficit of the century and gold stock falls below USD 10 billion.On 15 August convertibility of the dollar is suspended and the dollar is allow to float.On 17 December the Smithsonian Agreement devalues the dollar against gold and fixes new parities with wider bands(plus or minus 2.25%instead of 1%)
38、.Dollar convertibility into gold is not reinstated.,1972 The EC countries,Denmark and Great Britain agree to maintain a narrow band of 1.125%among themselves while maintaining the band of 2.25%versus the dollar.1973 the dollar is devalued and many currencies are allowed to floatOil producing countri
39、es establish an embargo.,1974 US eliminates restrictions on capital outflows.France withdraws from the joint float.The IMF redefines the value of the SDR(Instead of reflecting the value of the dollar,it reflects a basket of 16 currencies).1976 a new international monetary system of floating exchange
40、 rates is agreed on in Jamaica,Gold is demonetized.,1979 On 13 March the European Monetary System(EMS)is establishedOn 10 October the Fed announces its new anti-inflation monetary policy that will focus on the money supply rather than interest rates.1980 IMF simplifies the value of the SDR.1982 In A
41、ugust Mexico closes its foreign exchange markets and is unable to meet payments on its foreign debt.,1983 IMF raises its quotas from SDR 61.03 billion to SDR 90 billion.1985 In Sep.the Group of Five(G-5)came up with the Plaza Agreement to push down the value of the dollar.1987The Group of Five plus
42、Canada and Italy(G-7)negotiated the Louvre Accord,called for to slow the dollars fall The single European Act is established to eliminate all remaining barriers on goods,labor and capital within the EC by 1992.,1990 the first step towards European economic and monetary union(EMU)called for in the Ma
43、astricht Treaty.1994 the second step towards EMU begins with the creation of the European Monetary Institute,which is the precursor of the European Central Bank.1998 Designation by the governments of the 11 countries in the euro-zone,creation of the European Central Bank and nomination of its direct
44、ors.,1999 the third phase of EMU begins on 1 January,the final conversion rates of the participating currencies are fixed,the euro is born and the ECU ceases to exist.19992002 ECB exchanges individual currencies at the official rate established on 1 January 1999 and prepares for the transition to th
45、e euro.2002 Bills and coins denominated in euros are issued and substituted for the individual currencies of the participating countries.,What Is the Euro?,The euro is the single currency of the European Monetary Union which was adopted by 11 Member States on 1 January 1999.These original member sta
46、tes were:Belgium,Germany,Spain,France,Ireland,Italy,Luxemburg,Finland,Austria,Portugal and the Netherlands.,Euro conversion rates,What is the official sign of the euro?,The sign for the new single currency looks like an“E”with two clearly marked,horizontal parallel lines across it.It was inspired by
47、 the Greek letter epsilon,in reference to the cradle of European civilization and to the first letter of the word Europe.,the euro notes and coins?,There are be 7 euro notes and 8 euro coins.The notes are:500,200,100,50,20,10,and 5.The coins will be:2 euro,1 euro,50 euro cent,20 euro cent,10,euro ce
48、nt,5 euro cent,2 euro cent,and 1 euro cent.The euro itself is divided into 100 cents,just like the U.S.dollar.,Value of the Euro in U.S.Dollars,January 1999 to February 2004,The Long-Term Impact of the Euro,If the euro proves successful,it will advance the political integration of Europe in a major
49、way,eventually making a“United States of Europe”feasible.It is likely that the U.S.dollar will lose its place as the dominant world currency.The euro and the U.S.dollar will be the two major currencies.,Summary,Floating exchange rate Fixed exchange rate and Defense through official interventionSterilizationTemporary and long DisequilibriumExchange controlInternational Currency Experience,
