Fixed Exchange Rate

10 Key excerpts on "Fixed Exchange Rate"

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  eBook - PDF

  Macroeconomics

  • William Boyes, Michael Melvin(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  New issues of domestic currency are typically backed in some fixed ratio (like 1-to-1) by additional holdings of the key foreign currency. Fixed peg The exchange rate is fixed against a major currency or some basket of curren-cies. Active intervention may be required to maintain the target pegged rate. Horizontal bands The exchange rate fluctuates around a fixed central target rate. Such target zones allow for a moderate amount of exchange-rate fluctuation while tying the currency to the target central rate. Note that the countries that use the euro as their currency are listed as “Independently floating.” The euro floats against other currencies, but each of the member nations of the euro has no separate national money. Table 2 lists the end-of-year exchange rates for several currencies versus the U.S. dollar beginning in 1950. For most of the currencies, there was little movement in the 1950s and 1960s, the era of the Bretton Woods agreement. In the early 1970s, exchange rates began to fluctuate. More recently, there has been considerable change in the foreign exchange value of a dollar, as Table 2 illustrates. R E C A P 1. Under a gold standard, each currency has a fixed value in terms of gold. This arrangement provides for Fixed Exchange Rates between countries. 2. At the end of World War II, the Bretton Woods agreement established a new system of Fixed Exchange Rates. Two new organizations—the International Monetary Fund (IMF) and the World Bank—also emerged from the Bretton Woods conference. 3. Fixed Exchange Rates are maintained by gov-ernment intervention in the foreign exchange market; governments or central banks buy and sell currencies to keep the equilibrium exchange rate steady. 4. The governments of the major industrial coun-tries adopted floating exchange rates in 1973. In fact, the prevailing system is characterized by managed floating—that is, by occasional government intervention—rather than being a pure free-market-determined exchange-rate system.

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  Economics for Financial Markets

  • Brian Kettell(Author)
  • 2001(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  At issue is the extent to which a country’s economic performance and the mechanism whereby monetary and fiscal policies affect inflation and growth are dependent on the exchange rate regime. There is no perfect exchange rate system. What is best depends on a particular economy’s characteristics. A useful analysis in the IMF’s May 1997 World Economic Outlook considers some of the factors which affect the choice. These include the following. Size and openness of the economy . If trade is a large share of GDP, then the costs of currency instability can be high. This suggests that small, open economies may be best served by Fixed Exchange Rates. Inflation rate . If a country has much higher inflation than its trading partners, its exchange rate needs to be flexible to prevent its goods from becoming uncompetitive in world markets. If inflation differentials are more modest, a fixed rate is less troublesome. Labour market flexibility . The more rigid wages are, the greater the need for a flexible exchange rate to help the economy to respond to an external shock. Degree of financial development . In developing countries with immature financial markets, a freely floating exchange rate may not be sensible because a small number of foreign exchange trades can cause big swings in currencies. The credibility of policymakers . The weaker the reputation of the central bank, the stronger the case for pegging the exchange rate to build confidence that inflation will be The global foreign exchange rate system and the ‘Euroization’ of the currency markets 179 controlled. Fixed Exchange Rates have helped economies in Latin America to reduce inflation. Capital mobility . The more open an economy to inter-national capital, the harder it is to sustain a fixed rate.

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  Introduction to International Economics

  • Henk Jager, Catrinus Jepma(Authors)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  CHAPTER 19 Irrevocably Fixed Exchange Rates: Recent Experiences 19.1 Introduction In 1973 the worldwide system of adjustably pegged exchange rates ended when the exchange-rate system agreed at Bretton Woods in 1944 was shattered. The world’s major currencies have been floating since this time. However, around the world there are still several ‘islands’ of countries where variations of fixed exchange-rate regimes have been maintained. In effect, these Fixed Exchange Rates were intermediate regimes, such as adjustable pegs and crawling pegs. The world debt crisis of the 1980s and the currency crises of the 1990s occurred in countries with such regimes. Through these disappointing experiences it is not surprising that the so-called bipolar view, that for financially open emerging economies these intermediate regimes are prone to crises and that only extreme variants of fixed and floating exchange rates might be crisis-free, received broad support in the fallout from the Asian crisis of 1997. Weaker versions of Fixed Exchange Rates are deemed to offer speculators a one-way bet to profit. If a currency is considered weak, mon-etary authorities will either succeed in defending the exchange rate (with no change in the rate) or fail (and the rate will change substantially in the expected direction). This is a bifurcation in which speculators will suffer no losses, but may achieve substantial profits. This chapter analyses a number of attempts since 1990 to implement extreme variants of Fixed Exchange Rates and considers the feasibility of each variation. Each scheme is closely connected to the concept of monetary integration, which can be interpreted as either a state or a process. As a state, monetary integration is the stage at which the countries concerned have irrevocably fixed mutual exchange rates (without fluctuation margins) for their freely convertible currencies. Generally, these countries have abolished any restric-tions on mutual capital movements.

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  The Economics of Common Currencies

  Proceedings of the Madrid Conference on Optimum Currency Areas

  • Harry Johnson, Alexander Swoboda, Harry G. Johnson, Alexander K. Swoboda(Authors)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  ART I THE ECONOMICS OF Fixed Exchange RateS Passage contains an image Chapter 1

  TWO ARGUMENTS FOR FIXED RATES*

  ARTHUR B. LAFFER

  University of Chicago

  Few issues in economics have inspired so much debate as the issue of the relative desirability of flexible, pegged and Fixed Exchange Rate systems for the world economy. Each system has its proponents, but at the moment by far the most favoured among economists is the flexible exchange rate system. In this paper two purely theoretical arguments are presented which tend to favour Fixed Exchange Rates.1 The first argument focuses on the efficiency of the adjustment process under conditions of anything other than a perfectly flexible price level and the second on the efficiency of the allocation of real resources under equilibrium conditions. Given the current state of the debate, I take a system of flexible exchange rates as the alternative to a permanently Fixed Exchange Rate system.

  As a purely theoretical matter, flexible and permanently Fixed Exchange Rates can be differentiated by the ability of the private sector of an economy to vary the nominal quantity of domestic money via the balance of payments.2 If, other things being equal, the private sector of the economy in question can alter the nominal stock of domestic money, then this economy is operating with Fixed Exchange Rates. On the other hand, with a flexible exchange rate system, the private sector of the economy cannot alter the nominal quantity of money. With Fixed Exchange Rates, since the domestic currency price of foreign exchange is by definition fixed, the nominal quantity of money will move in response to induced balance-of-payments changes.3

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  Exchange Rate Regimes

  Fixed, Flexible or Something in Between?

  • I. Moosa(Author)
  • 2006(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  With monetary policy capable only of affecting the price of non-traded goods, the result would be considerable variability in both the price level and relative prices. This volatility would make the real rate of return on the domestic currency uncertain compared with that of the foreign currency. It would also make the latter preferable as the numeraire in domestic accounts and contractual obligations. This is the currency substitution argument for Fixed Exchange Rates. Leaving the currency substitution argument aside, it is still arguable that Fixed Exchange Rates are more suitable for a small economy, which is typically a price-taker in world markets. If this is the case, a small country cannot respond to an adverse exchange rate movement by changing prices. Hence, a small country might as well avoid exchange rate fluctuations altogether by adopting Fixed Exchange Rates. Fixed Exchange Rates and fiscal discipline It is arguable that Fixed Exchange Rates provide more fiscal discipline than flexible exchange rates. The rationale for this argument is that lax fiscal policies eventually lead to a collapse of the peg, giving rise to significant political and economic costs, which means that a lax fiscal policy at present leads to punishment in the future. This potential punishment forces the government to have fiscal discipline. Canavan and Tommasi (1997) argue that an exchange rate anchor provides dis- cipline because it is much easier for the public to monitor the nominal exchange rate than other variables. Fixed versus Flexible Exchange Rates 69 This argument does not go without challenge, however. Tornell and Velasco (1995, 1998) point out that by delaying the inflationary conse- quences of fiscal laxity, a Fixed Exchange Rate regime can actually induce impatient policy-makers to spend more.

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  Introduction to International Economics

  • Dominick Salvatore(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  A careful review of these arguments does not lead to any clear-cut conclusion that one system is overwhelmingly superior to the other. To be sure, at the time of the collapse of the Fixed Exchange Rate system in the early 1970s, the majority of economists seemed to lean toward flexible exchange rates. However, as a result of the great volatility in exchange rates experienced over the past four decades, the balance seems to have moved toward fixed or managed rates. It seems that economists often compare the painfully obvious weaknesses of whatever the prevailing exchange rate system is to an idealized alternative system. This is contrasted to the more or less consistent preference of businesspeople, bankers, and government officials for fixed rates, or at least greatly restrained fluctuations. No one can deny the important benefits of having a single currency throughout a nation and thus permanently Fixed Exchange Rates between the various areas of the nation. For example, a dollar in New York can be exchanged for a dollar in San Francisco or in any other part of the United States. But then the debate over fixed versus flexible exchange rates becomes essentially a debate over what is an optimum currency area, or how large the area covered by permanently Fixed Exchange Rates can be before the benefits of fixed rates are overwhelmed by their drawbacks. 380 Part Six The International Monetary System: Past, Present, and Future In the final analysis, whether flexible or Fixed Exchange Rates are better Concept Check Why is the choice of fixed versus flexible exchange rate important? may very well depend on the nation or region involved and the conditions under which it operates. We will see that, in general, a Fixed Exchange Rate (or a greater degree of fixity) is preferable if disturbances are predominantly monetary (such as inflation).

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  Shaking the Invisible Hand

  Complexity, Endogenous Money and Exogenous Interest Rates

  • B. Moore(Author)
  • 2006(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  One result of the increased non-transparency of future interest rate and low exchange rate movements has been that both agents and macroeconomists are much less confident of the longer future in open economies as compared with closed economies. No one knows when or by how much future exchange rates are going to change, and the consequences are undecipherable. To model an open economy it is necessary to distinguish the financial regime in place: freely floating, managed floating, or firmly Fixed Exchange Rates. One must distinguish the degree of and manner in which capital movements are controlled and regulated. No real- world exchange rate has ever been fixed forever. So the time period over which the exchange rate has been pegged and the period over which it is expected to be pegged in the future must be considered. As the complexity increases, the modeling task eventually becomes insuperable. 7 The degree that exchange rates are fixed determines the degree of autonomy domestic CBs possess to set the key domestic short-term rate (bank rate) relative to the rates ruling in the center. In a closed economy the CB is the monopoly supplier of system liquidity and its interest rate-setting procedure is unambiguous. But in open economies so long as capital controls do not prohibit all capital movements, a degree of control that in practice is impossible to sustain, funds can usually be obtained from foreign lenders and so indirectly from foreign CBs. How are an economy’s interest rate and exchange rate then determined? If the exchange rate is permanently fixed and financial capital is perfectly mobile, the domestic CB will lose all ability to exogenously control the short- term rate.

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  International Macroeconomics

  • Peter J. Montiel(Author)
  • 2015(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  These are often referred to as emerging market economies. The vast majority of these countries retained some form of Fixed Exchange Rate regime after the collapse of the Bretton Woods system, but as their degree of integration with world financial markets has increased, many of them have engaged in repeated changes of their official parities, have adopted hard pegs, or have switched to floating exchange rates, often in the wake of dramatic sell offs of their currencies in a crisis atmosphere. We will discuss some of these crises over the course of this chapter. Why should financial integration have made exchange rate policies in emerging-market economies so unstable? To answer this question, in this chapter we will investigate the macroeconomics of Fixed Exchange Rates in a financially integrated world. Since the gold standard system featured Fixed Exchange Rates in a context of a high degree of international financial integration, we already did much of this work when we analyzed how the gold standard worked in Chapter 6. However, we have yet to analyze the macroeconomics of soft exchange rate pegs under conditions of high capital mobility. We undertake this analysis in the first section of this chapter. We will follow up that analysis by looking at the factors that cause currency crises (dramatic movements in nominal exchange rates), focusing especially on how the likelihood of such a crisis for a country with a Fixed Exchange Rate may be influenced by its degree of integration with world capital markets. This discussion reveals that soft pegs are indeed likely to prove very fragile when capital mobility is high, explaining the transitions in exchange rate regimes that have been undergone by many emerging economies in recent years. We then explore one possible response to the fragility of soft pegs: moving to modern versions of hard pegs.

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  Flexible Exchange Rates

  • Jan Herin(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  Exchange rates are determined primarily by the conditions for equilibrium between the demands for the stocks of various national monies and the stocks of these monies available to be held. Second, like all prices determined in asset markets, exchange rates are strongly influenced by asset holders' expecta-tions of the future behavior of asset prices. Since national monetary authorities can exert substantial control over the supplies of national monies, expectations concerning the behavior of these authorities are of critical importance for the behavior of exchange rates. Third, while the exchange rate and the official settlements balance are monetary phenomena, they are not exclusively monetary phenomena. Changes in exchange rates are frequently induced by real factors, operating through monetary channels; and, changes in exchange rates usually have real effects which are of legitimate concern to government policy. Fourth, the problems of policy conflict which exist under a system of fixed rates are potentially reduced, but not eliminated, under a regime of controlled floating. The relaxation of the commitment to fixed parities allows greater independence in use of monetary and fiscal policies by introducing an additional policy instrument, the exchange rate, but undesired real effects of exchange rate changes limit the usefulness of this additional instrument. I. A Monetary Approach to Exchange Rate Theory The monetary approach to balance of payments analysis is built on the assumption that the demand for money is a stable function of a limited number of arguments, at least over periods of a year or two. This money demand function constrains the equilibrium size of the money supply. Under a system of fixed rates, where governments are committed to buy or sell foreign exchange to maintain the par value of their national money, the foreign source compo-nent of the money supply is endogenous.

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  Interest Groups And Monetary Integration

  The Political Economy Of Exchange Regime Choice

  • Carsten Hefeker(Author)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  With shocks to Europe's national economies relatively symmetric in incidence, the costs of abandoning the exchange rate are low (Eichengreen 1993a). I return to this in Chapter 8. The Benefits of Flexible Exchange Rates Those for whom cross-border and foreign currency transactions are incon-sequential stand to lose the most from fixed parities. For them predictable exchange rates are of little or no value, whereas national reduced autonomy in the formulation of macroeconomic policy may be important. The possibility of an expansive monetary policy, in contrast, is esteemed because monetary policy can have at least short-run effects on output and em-ployment in the economy. One explanation for this may be sticky nominal wages because of long-term nominal contracts, union monopoly power or price-adjustment costs. Another reason can be found in the literature on coordination failures (see Blanchard 1990, for an overview). If the willingness of an agent to reduce his nominal wage depends on the willingness of others to do so, then a coordination problem arises. That means, no agent is willing to be the first to lower his nominal wage demand. The real wage can nevertheless be brought back in line with prices by inflation and devaluation? A Fixed Exchange Rate in contrast reduces the flexibility of monetary policy. Imagine a country subjected to a negative shock. If the exchange rate were of no concern, the central bank could initiate expansionary open-market policies to stabilize output. Were it however committed to the maintenance of an exchange rate target, reflation would be impossible because a rapid increase in domestic credit would threaten to produce a loss of international reserves, causing a fatal blow to confidence in exchange rate stability. Absent the possibility of reflation, other channels of adjustments would be required. The most obvious would be increased wage flexibility.

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