Floating Exchange Rate

11 Key excerpts on "Floating Exchange Rate"

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  eBook - PDF

  21st Century Economics: A Reference Handbook

  • Rhona C. Free(Author)
  • 2010(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  Proponents of the flexible exchange rate system argue that Floating Exchange Rates provide monetary policy autonomy as the central bank is not required to intervene in the foreign exchange market to maintain a given value for the currency and insulation from external shocks. In his 1969 article praising the benefits of Floating Exchange Rates, economics professor Harry G. Johnson even argued that Floating Exchange Rates are an essential component of the national autonomy and independence of each country. This national autonomy, he argues, is essential for the efficient organization and development of the global economy. On the down side, flexible exchange rates have often been associated with destabilizing speculation. However, propo-nents of flexible exchange rates argue that, to the contrary, speculation by rational agents should reduce exchange rate volatility. Economist and Nobel laureate Milton Friedman (1953) argues that if there is a domestic currency apprecia-tion that is expected to be temporary, there is an incentive for holders of domestic currency to sell some of their holdings, acquire foreign currency, and then buy the domestic cur-rency back at a lower price. By behaving this way, specula-tors meet part of the excess demand for domestic currency and accelerate the process of returning to the long-term equilibrium value of the currency. Friedman stated that those who argue that speculation can be destabilizing in the for-eign exchange market do not realize that this is equivalent to saying that speculators constantly lose money because spec-ulation can be destabilizing only if speculators sell when the currency is cheap and buy when it is expensive. He suggests that speculators who behave this way will be driven out of the market relatively quickly. The second type of regime that must be defined is the fixed exchange rate regime, in which the value of the cur-rency is tied to the value of some other currency.

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  Strengthening the International Monetary System : Exchange Rates, Surveillance, and Objective Indicators

  • Andrew Crockett, and Morris Goldstein(Authors)
  • 1987(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  53 They also maintain that the characteristics that make the present system relatively resilient may have other undesirable implications for its performance while it lasts. For example, the great diversity of exchange arrangements may make it more difficult to define “rules of the game” for macroeconomic policies that are sufficiently specific to be effective. Indeed, it is the very lack of such recognized rules of the game, especially for major industrial countries with floating rates that, according to critics, is responsible for the severe misalignments of the floating rate period. Similarly, while they agree that the present system allows the market “to take a view” when centralized decisions are not feasible, they argue that the present system does not offer a sufficient framework for reaching a satisfactory multilateral decision; in addition, the market’s view is too often the “wrong” view. Finally, the same “flex” in exchange rates that provides a defense against “hot money” flows often proves a liability when exchange rates become divorced from fundamentals and get carried along by self-fulfilling destabilizing speculation.

  Proposals for Improving Exchange Rate Stability

  As suggested earlier, both Reports conclude that the functioning of the exchange rate system needs to be improved. Both Reports also agree that perhaps the single most important element in achieving such an improvement lies in the better discipline and coordination of macroeconomic policies in the major industrial countries. The key question then is what mechanisms or channels, including Fund surveillance, are available for reaching that latter objective. Three types of proposals can be identified in the Group of Ten and Group of Twenty-Four Reports as ways of improving exchange rate stability: the adoption of “target zones” for the exchange rates of major currencies; the adoption of “objective indicators” or “targets” for macroeconomic policies in major industrial countries that could be used as a framework for the first stage of multilateral Fund surveillance; and the adoption of policy adjustments and of changes in the procedures for Fund surveillance that could be accomplished within existing exchange rate arrangements and the existing institutional framework for surveillance.

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  The International Monetary System

  Highlights From Fifty Years Of Princeton's Essays In International Finance

  • Peter B Kenen(Author)
  • 2019(Publication Date)
  • Taylor & Francis

    (Publisher)

  ' .. Pi/== ~il.i a;T;, while the percentage change in the domestic relative price of trada-bles is ' ..... ' .,. ro-Pni == r1 + Ptf-PnJ == ri -~i#.i a;r;-l' 1 u. b. Floating Exchange Rate By free floating, a cou~try with sufficiently developed exchange and financial markets can allow the market to determine its exchange rate vis-a-vis the dollar and all other currencies. In the context of the theory developed above, the exchange rate will then depend on movements in the domestic price of tradable goods as given by Figure 2 and exogenous movements in the world price of tradable goods. As pointed out in the discussion of stabilization policy in section 3, such a policy will minimize the variance of domestic prices when the most important shocks come from exogenous changes in world prices rela-tive to domestic prices or from exogenous changes in exchange rates. Exchange Policies for Developing Countries 227 Free floating will not be optimal if most shocks come from internal sources such as crop failures. If most shocks come from changes in the terms of trade, a country with an elastic demand for imports will have less variance in its prices under Floating Exchange Rates than under pegged rates, generally speaking. The converse is true for a country with an inelastic demand for imp01ts, as argued in section 3. Fmther-more, if the country is very open, in the sense that the prop01tion of nontraded goods is very low, monetary policy becomes crucial. In such cases, the NN curve essentially collapses into the TT curve, leav-ing indeterminate the relative prices of traded and nontraded goods. The absolute price level and the exchange rate are then determined solely by the money supply. A result similar to free floating can be obtained by government-managed floating designed to stabilize the domestic relative price of tradable goods.

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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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  Flexible Exchange Rates

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

    (Publisher)

  First, an exchange rate is a relative price of two national monies and is deter-mined by the conditions for atoclc equilibrium in the markets for national monies· and not in flow markets for goods. Secondly, one of the factors which influences the demand for money and, therefore, the exchange rate, is the expected future exchange rate. That expectation is formed rationally and depends, therefore, on expected future monetary policy. Thirdly, the exchange rate is not purely a monetary phenomenon. Real factors which affect the de-mand for money also affect the exchange rate. Fourthly, the problem of policy conflict which exists under fixed rates is modified rather than eliminated by floating rates. The basic monetary approach is sketched out in part I of the paper. That approach centres on the equations: M•=R+O Mrl=L( )EP 111 M'=Ma where R =foreign exchange reserves 0 =domestic credit L( ) =demand for real balances (1) (2) (3) liS M. Parkin P w =world price level E =exchange rate (units of domestic currency per unit of foreign currency) M =nominal money balances (superscripts d and s denote demand and supply). Eq. (1) is a definition of the relationship between the supply of money, foreign exchange reserves and domestic credit which arises from a consolidation of the balance sheets of the central bank and the commercial banks. Eq. (2) is a demand for money function which incorporates degree one homogeneity in the price level and assumes purchasing power parity (i.e., the domestic price level is the product of the exchange rate (E) and the world price level (Pw)). Eq. (3) is the stock equilibrium condition. Combining (1), (2) and (3) (4) Under fixed exchange rates, E is fixed and a rise in the value of L( ) (arising from a rise in real income or a fall ih the nominal interest rate), a rise in Pw or a fall in 0 will lead to an overall balance of payments surplus-i.e., a rise in R.

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  Optimum Currency Areas : New Analytical and Policy Developments: New Analytical and Policy Developments

  • Leonardo Leiderman(Author)
  • 1997(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  When a decision must be made on the adoption of an exchange rate regime, as Jacob Frenkel has stressed, the focus must be placed where it belongs, that is, on whether the regime will foster good or bad economic policies. From this standpoint, what the concept of currency areas added to the debate of fixed versus Floating Exchange Rates is the idea that an optimum currency domain has really little to do with national frontiers. In his seminal article on the subject, Mundell explored the question of whether all national currencies should float. In other words, whether nations should take it for granted that flexible exchange rates represented an appropriate regime for each and all of them.

  Experience on this front seems to conform to a cyclical pattern: countries adopt a fixed exchange rate regime; they become disenchanted with the constraints they impose on their national policy autonomy and they move toward flexible exchange rate arrangements; they then balk at the uncertainties created by unfettered national policy discretion and seek to contain them by reverting toward less flexible arrangements.

  The advantages of fixed exchange rate regimes are of course those of “pooling.” Countries with inappropriate economic policies “export” part of their imbalances, making others share in their costs. Discomfort with such exports grows over time, particularly in those countries with relatively better economic policies—those that “import” the costs of imbalance and export the benefits of balance—and pressure builds up for insulation and, hence, for floating. In this manner, international exchange arrangements tend to move from rules to discretion, reflecting shifts in the balance of national and international interests, to which I referred earlier.

  The problem with discretion-based international regimes, of course, is that they make it harder to assign unambiguously responsibilities for policy adjustments. In situations of imbalance, should primary responsibility for policy correction fall upon deficit or surplus countries? The practical counterpart of this assignment dilemma is to identify the inappropriateness of policies and the consequent need for weighing a variety of policy indicators, not all of which point in the same direction or are of the same importance. In this context, the merits of the simplicity of a fixed exchange rate are clear: domestic policies should be compatible with the external constraint or be appropriately adjusted. It is, in essence, a single indicator system.

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  The Economics of Exchange Rates (Collected Works of Harry Johnson)

  Selected Studies

  • Jacob Frenkel, Harry Johnson, Jacob A. Frenkel, Harry G. Johnson(Authors)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  CHAPTER 3

  THE EXCHANGE RATE, THE BALANCE OF PAYMENTS, AND MONETARY AND FISCAL POLICY UNDER A REGIME OF CONTROLLED FLOATING MICHAEL MUSSA

  University of Chicago, Chicago, Illinois, USA

  ABSTRACT

  This paper considers the extension of the fundamental principles of the monetary approach to balance of payments analysis to a regime of Floating Exchange Rates, with active intervention by the authorities to control rate movements. It makes four main points. First, the exchange rate is the relative price of different national monies, rather than national outputs, and is determined primarily by the demands and supplies of stocks of different national monies. Second, exchange rates are strongly influenced by asset holders’ expectations of future exchange rates and these expectations are influenced by beliefs concerning the future course of monetary policy. Third, “real” factors, as well as monetary factors, are important in determining the behavior of exchange rates. Fourth, the problems of policy conflict which exist under a system of fixed rates are reduced, but not eliminated, under a regime of controlled floating. A brief appendix develops some of the implications of “rational expectations” for the theory of exchange rates.

  INTRODUCTION

  The current system of controlled floating differs significantly from the exchange rate system which existed prior to 1971 and from textbook descriptions of freely flexible rates. Governments no longer seek to maintain fixed parities; neither do they forego direct intervention in the foreign exchange markets. Nevertheless, it is the central contention of this paper that the basic theoretical framework of the monetary approach to the balance of payments, developed for a fixed rate system, remains applicable. This approach emphasizes that both the balance of payments (meaning the official settlements balance) and the exchange rate are essentially monetary phenomena.1

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  Inflation, Growth and International Finance

  • Alec Cairncross(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  vice versa. To the extent that this is true, control over the rate of exchange is an indispensable element in control over the economy and is not likely to be abandoned by any government seeking to exercise such control.

  THE CASE IN FAVOUR OF FLOATING RATES

  Let us now approach the question from the other side and ask why a government should abandon control over exchange rates. What is the logical foundation of the case for freely floating rates?

  The Need for Flexibility

  First of all, there is the argument that the rate of exchange is a price like any other price so that it is inherently wrong to seek to control it in a world in which prices are left to be determined by market forces. This can hardly be regarded as a very powerful argument in a society in which many prices for public services are not market-determined (health, education, defence, roads, justice, etc.) while others are regulated by publicly appointed agencies. But in any event the rate of exchange is not just a price like other prices. There are at least four important points of difference.

  To begin with, the rate of exchange is more than a price: it is the basis on which the prices of all traded goods are determined. In this it resembles the price of labour (which is also not ‘just a price’) except that there is no single price of labour in the sense in which there is a single price (within narrow limits) for foreign exchange of all kinds. The wage structure may be relatively stable but it is nowhere near so stable as the structure of exchange rates. If the exchange rate changes, therefore, the consequences are of a quite different order from the consequences of a change in any other ‘price’. The entire price structure—notably the relation between the price of non-traded goods and services (including labour services) and the price of traded goods and services—undergoes a change which affects both the direction and the level of economic activity. No other price change within the discretion of the Government (except perhaps the rate of interest) has anything like the same effect on the economic performance of the whole economy.

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  Exchange Rate Theory and Practice

  • John F. Bilson, Richard C. Marston, John F. Bilson, Richard C. Marston(Authors)
  • 2007(Publication Date)
  • University of Chicago Press

    (Publisher)

  A Floating Exchange Rate would generate substantial upward pressure on the exchange rate during restrictive periods, followed by downward pres- sure during expansionary periods. 15.3 A Classification of Exchange Rate and Monetary Policy Regimes in Ten Countries Actual exchange rate and monetary policy regimes do not fall neatly into pigeonholes labeled “pegged,” “floating,” “control of MI ,” or “control of bank credit.” Even a pegged exchange rate fluctuates freely between its upper and lower limits and can have the limits changed. And, as recent experience has made clear, most cases of floating rates involve a significant degree of management via central bank intervention in the exchange market. Furthermore, the existence of generalized floating among the major world currencies since 1973 has made it impossible for any country to do more than peg to a subset of the rest of the world’s currencies. 507 Exchange Rate Policy and Monetary Policy in Ten Industrial Countries The simple classification of a currency as “pegged” or “floating,” as seen, for example, in International Financial Statistics, thus needs to be supplemented by some additional information on the degree of flexibility allowed in the exchange rate. Table 15.2 shows in column 1 the formal classification of each country’s exchange rate regime during the 1970s, but columns 2 and 3 add information on the variability of the effective exchange rate and central bank intervention relative to GDP. As might be expected, countries with floating rates have higher average variability in their effective exchange rates than countries which peg (1.65 vs. 1.29), although Belgium and the Netherlands rank lower than the other “peggers.” The second half of table 15.2 classifies countries according to differences in monetary policy. Column 4 gives the primary monetary target, while column 5 indicates the primary instrument through which monetary policy is carried out.

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  The Jingshan Report

  Opening China's Financial Sector

  • China Finance 40 Forum Research Group(Author)
  • 2020(Publication Date)
  • ANU Press

    (Publisher)

  145 4 RMB Exchange Rate: Moving Towards a Floating Regime Zhang Bin 1 Introduction The RMB exchange rate formation mechanism has undergone frequent adjustments since the 1980s, with the transition from a double-track exchange rate system to a single exchange rate system, a de facto fixed regime (pegged to the USD) during the financial crisis, as well as many attempts in normal periods to reform the exchange rate regime so that it can respond to market changes. The major challenge is that the exchange rate does not respond adequately to changes in market supply and demand. When the exchange rate deviates from economic fundamentals, expectation for one-way currency fluctuation and large-scale capital flow follow. Authorities are then forced to intervene in the foreign exchange market. This affects the independence and effectiveness of monetary policy and also jeopardises domestic economic stability. Additionally, regular intervention in the foreign exchange market has negative effects on economic upgrading, RMB internationalisation and outbound investment. Since the beginning of 2017, supply and demand in the foreign exchange market have been more balanced, and the time is right for further reform. International experience suggests that reducing intervention in the foreign 1 Senior Fellow at the China Finance 40 Forum. THE JINGSHAN REPORT 146 exchange market will not lead to a large depreciation of the RMB, given China’s economic fundamentals. Two strategies can be used to introduce a Floating Exchange Rate regime: free-floating regime, and allowing a wide band for the RMB exchange rate fluctuation against a basket of currencies. The latter could well be a transition plan towards a free-floating regime.

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  International Macroeconomics

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

    (Publisher)

  The question becomes more meaningful when applied to a fixed exchange rate economy, because in that case the nominal exchange rate is a policy variable, so it is at least possible to imagine an exogenous policy decision to devalue the exchange rate, possibly, say, to secure a competitive advantage for domestic exporters. But decisions to depreciate the currency are not always made in this way. Sometimes they are driven by a desire to adjust the real exchange rate in response to a real shock that causes the equilibrium value of the real exchange rate to depreciate. In this case, we also would not expect the domestic price level to increase, since under these circumstances the fixed exchange rate is simply mim- icking what a Floating Exchange Rate would do. It is only when a country undertakes an exogenous depreciation of a fixed nominal exchange rate by an amount that exceeds any change in the equilibrium real exchange rate that we would expect the domestic price level to increase as a result of the exchange rate policy, as shown in Appendix 13.2. 344 Floating Exchange Rates straight line with slope equal to 1 in m-q space, and the solution for q  determined from the goods market picks out a point on this line that determines the long-run equilibrium value of m. Changes in variables that affect the demand for money shift the negatively sloped line vertically, thus altering the equilibrium value of the money supply at a given value of q  , while changes in q  change the equilibrium value of m by inducing movements along the negatively-sloped line. Based on what has been said so far, it is easy to see what would happen if, instead of being held constant, the exchange rate were to be depreciated by a constant proportional amount, say x percent, each year. This is sometimes referred to as a crawling peg, as indicated in Box 13.6. This is analogous, under fixed exchange rates, to a constant proportionate change in the money supply under floating rates.

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